# ASC 842-50-55: Leases — Leveraged Lease Arrangements — 55 Implementation Guidance and Illustrations

Source: FASB Accounting Standards Codification, Basic View

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## ASC 842-50-55: 55 Implementation Guidance and Illustrations

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#### Implementation Guidance

##### [842-50-55-1](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-1)

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Although the carrying amount of an asset acquired previously may not differ significantly from its [fair value](https://asc.understandingaccounting.org/glossary/f/#fair-value "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."), it is unlikely that the two will be the same. However, regulated utilities have argued that the carrying amounts of certain of their assets always equal the fair value based on the utility's ability to recover that cost in conjunction with a franchise to sell a related service in a specified area. That argument is not valid when considering the value of the asset to a third-party purchaser that does not own that franchise.

##### [842-50-55-2](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-2)

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A [delayed equity investment](https://asc.understandingaccounting.org/glossary/d/#delayed-equity-investment "In leveraged lease transactions that have been structured with terms such that the lessee's rent payments begin one to two years after lease inception, equity contributions the lessor agrees to make (in the lease agreement or a separate binding contract) that are used to service the nonrecourse debt during this brief period. The total amount of the lessor's contributions is specifically limited by the agreements.") frequently obligates the [lessor](https://asc.understandingaccounting.org/glossary/l/#lessor "An entity that enters into a contract to provide the right to use an underlying asset for a period of time in exchange for consideration.") to make up the shortfall between rent and debt service in the first several years of the transaction. The type of recourse debt resulting from the delayed equity investment does not contradict the notion of nonrecourse and, therefore, does not preclude [leveraged lease](https://asc.understandingaccounting.org/glossary/l/#leveraged-lease "From the perspective of a lessor, a lease that was classified as a leveraged lease in accordance with the leases guidance in effect before the effective date and for which the commencement date is before the effective date.") accounting as long as other requirements of leveraged lease accounting are met. The lessor's related obligation should be recorded as a liability at present value at [lease inception](https://asc.understandingaccounting.org/glossary/l/#lease-inception "The date of the lease agreement or commitment, if earlier. For purposes of this definition, a commitment shall be in writing, signed by the parties in interest to the transaction, and shall specifically set forth the principal provisions of the transaction. If any of the principal provisions are yet to be negotiated, such a preliminary agreement or commitment does not qualify for purposes of this definition.").

##### [842-50-55-3](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-3)

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Recognition of the liability would increase the lessor's net investment on which the lessor bases its pattern of income recognition. While the increase to the net investment results in an increase in income, it may be offset by the accrual of interest on the liability.

##### [842-50-55-4](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-4)

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The accounting for income taxes related to [leveraged leases](https://asc.understandingaccounting.org/glossary/l/#leveraged-lease "From the perspective of a lessor, a lease that was classified as a leveraged lease in accordance with the leases guidance in effect before the effective date and for which the commencement date is before the effective date.") set forth in this Subtopic is not consistent with the guidance in Topic 740 on income taxes.

##### [842-50-55-5](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-5)

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The integration of the results of accounting for income taxes related to leveraged leases with the other results of accounting for income taxes as required by Topic 740 is an issue if all of the following exist:

1.  a
    
    The accounting for a leveraged lease requires recognition of deferred tax credits.
    
2.  b
    
    The guidance in Topic 740 limits the recognition of a tax benefit for deductible temporary differences and carryforwards not related to the leveraged lease.
    
3.  c
    
    Unrecognized tax benefits in this paragraph could offset taxable amounts that result from future recovery of the net investment in the leveraged lease.

#### Illustrations

##### [842-50-55-6](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-6)

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This Example illustrates a lessor's accounting for a leveraged lease in accordance with the guidance in this Subtopic. It also illustrates one way of meeting the disclosure requirements in paragraphs [842-50-45-1](https://asc.understandingaccounting.org/asc/842/50/#842-50-45-1) and [842-50-50-1](https://asc.understandingaccounting.org/asc/842/50/#842-50-50-1) as applied to a leveraged lease. The Example does not encompass all circumstances that may arise about leveraged leases; rather, the Example is based on a single instance of a leveraged lease. The elements of accounting and reporting illustrated for this Example of a leveraged lease are as follows:

1.  a
    
    Cash flow analysis by years (see paragraph [842-50-55-8](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-8))
    
2.  b
    
    Allocation of annual cash flow to investment and income (see paragraph [842-50-55-9](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-9))
    
3.  c
    
    Journal entries for lessor's initial investment and first year of operation (see paragraph [842-50-55-10](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-10))
    
4.  d
    
    Financial statements including notes at end of second year (see paragraph [842-50-55-11](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-11))
    
5.  e
    
    Accounting for a revision in the estimated residual value of the leased asset assumed to occur in the eleventh year of the lease (from $200,000 to $120,000):
    
    1.  1
        
        Revised allocation of annual cash flow to investment and income (see paragraph [842-50-55-12](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-12))
        
    2.  2
        
        Balances in investment accounts at beginning of the eleventh year before revised estimate (see paragraph [842-50-55-13](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-13))
        
    3.  3
        
        Journal entries (see paragraph [842-50-55-14](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-14))
        
    4.  4
        
        Adjustment of investment accounts (see paragraph [842-50-55-15](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-15)).

##### [842-50-55-7](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-7)

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This Example has the following terms and assumptions.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-FFE32B68-D4FA-47F8-8DCA-50156C719AA2-low.gif)
    
    Cost of leased asset (equipment) "$1,000,000 " Lease term "15 years, dating from January 1, 1975" Lease rental payments "$90,000 per year (payable last day of each year)" Residual value "$200,000 estimated to be realized 1 year after lease termination; in the eleventh year of the lease the estimate is reduced to $120,000" Financing: Equity investment by lessor "$400,000 " Long-term nonrecourse debt "$600,000, bearing interest at 9% and repayable in annual installments (on last day of each year) of $74,435.30" Depreciation allowable to lessor for income tax purposes "7-year asset depreciation range life using double-declining-balance method for the first 2 years (with the half-year convention election applied in the first year) and sum-of-years digits method for remaining life, depreciated to $100,000 salvage value" "Lessor's income tax rate (federal and state)" 50.4% (assumed to continue in existence throughout the term of the lease) Investment tax credit "10% of equipment cost or $100,000 (realized by the lessor on last day of first year of lease)" Initial direct costs "For simplicity, initial direct costs have not been included in the illustration"

##### [842-50-55-8](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-8)

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Cash flow analysis by years follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-9EF71D09-A94A-42EB-8B66-2F87E40DB33F-low.gif)
    
    1 2 3 4 5 6 7 8 9 Year Gross Lease Rentals and Residual Value Depreciation (for Income Tax Purposes) Loan Interest Payments Taxable Income (Loss) (Col. 1- 2- 3) Income Tax Credits (Charges) (Col. 4 × 50.4%) Loan Principal Payments Investment Tax Credit Realized Annual Cash Flow (Col. 1- 3 + 5 - 6 + 7) Cumulative Cash Flow Initial Investment - - - - - - - " $(400,000)" " $(400,000)" 1 " $90,000 " " $142,857 " " $54,000 " " $(106,857)" " $53,856 " " $20,435 " " $100,000 " " 169,421 " " (230,579)" 2 " 90,000 " " 244,898 " " 52,161 " " (207,059)" " 104,358 " " 22,274 " - " 119,923 " " (110,656)" 3 " 90,000 " " 187,075 " " 50,156 " " (147,231)" " 74,204 " " 24,279 " - " 89,769 " " (20,887)" 4 " 90,000 " " 153,061 " " 47,971 " " (111,032)" " 55,960 " " 26,464 " - " 71,525 " " 50,638 " 5 " 90,000 " " 119,048 " " 45,589 " " (74,637)" " 37,617 " " 28,846 " - " 53,182 " " 103,820 " 6 " 90,000 " " 53,061 " " 42,993 " " (6,054)" " 3,051 " " 31,442 " - " 18,616 " " 122,436 " 7 " 90,000 " - " 40,163 " " 49,837 " " (25,118)" " 34,272 " - " (9,553)" " 112,883 " 8 " 90,000 " - " 37,079 " " 52,921 " " (26,672)" " 37,357 " - " (11,108)" " 101,775 " 9 " 90,000 " - " 33,717 " " 56,283 " " (28,367)" " 40,719 " - " (12,803)" " 88,972 " 10 " 90,000 " - " 30,052 " " 59,948 " " (30,214)" " 44,383 " - " (14,649)" " 74,323 " 11 " 90,000 " - " 26,058 " " 63,942 " " (32,227)" " 48,378 " - " (16,663)" " 57,660 " 12 " 90,000 " - " 21,704 " " 68,296 " " (34,421)" " 52,732 " - " (18,857)" " 38,803 " 13 " 90,000 " - " 16,957 " " 73,043 " " (36,813)" " 57,478 " - " (21,248)" " 17,555 " 14 " 90,000 " - " 11,785 " " 78,215 " " (39,420)" " 62,651 " - " (23,856)" " (6,301)" 15 " 90,000 " - " 6,145 " " 83,855 " " (42,263)" " 68,290 " - " (26,698)" " (32,999)" 16 " 200,000 " " 100,000 " - " 100,000 " " (50,400)" - - " 149,600 " " 116,601 " Totals " $1,550,000 " " $1,000,000 " " $516,530 " " $33,470 " " $(16,869)" " $600,000 " " $100,000 " " $116,601 "

##### [842-50-55-9](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-9)

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Allocation of annual cash flow to investment and income follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-CED16695-B3B5-4C52-92CA-1455FC8B924E-low.gif)
    
    1 2 3 4 5 6 7 Annual Cash Flow Components of Income (a) Year Lessor's Net Investment at Beginning of Year "Total (from Col. 8 of Paragraph 842-50-55-8)" Allocated to Investment Allocated to Income (b) Pretax Income Tax Effect of Pretax Income Investment Tax Credit 1 " $400,000 " " $169,421 " " $134,833 " " $34,588 " " $9,929 " " $(5,004)" " $29,663 " 2 " 265,167 " " 119,923 " " 96,994 " " 22,929 " " 6,582 " " (3,317)" " 19,664 " 3 " 168,173 " " 89,769 " " 75,227 " " 14,542 " " 4,174 " " (2,104)" " 12,472 " 4 " 92,946 " " 71,525 " " 63,488 " " 8,037 " " 2,307 " " (1,163)" " 6,893 " 5 " 29,458 " " 53,182 " " 50,635 " " 2,547 " 731 (368) " 2,184 " 6 " (21,177)" " 18,616 " " 18,616 " - - - - 7 " (39,793)" " (9,553)" " (9,553)" - - - - 8 " (30,240)" " (11,108)" " (11,108)" - - - - 9 " (19,132)" " (12,803)" " (12,803)" - - - - 10 " (6,329)" " (14,649)" " (14,649)" - - - - 11 " 8,320 " " (16,663)" " (17,382)" 719 206 (104) 617 12 " 25,702 " " (18,857)" " (21,079)" " 2,222 " 637 (321) " 1,906 " 13 " 46,781 " " (21,248)" " (25,293)" " 4,045 " " 1,161 " (585) " 3,469 " 14 " 72,074 " " (23,856)" " (30,088)" " 6,232 " " 1,789 " (902) " 5,345 " 15 " 102,162 " " (26,698)" " (35,532)" " 8,834 " " 2,536 " " (1,278)" " 7,576 " 16 " 137,694 " " 149,600 " " 137,694 " " 11,906 " " 3,418 " " (1,723)" " 10,211 " Totals " $516,601 " " $400,000 " " $116,601 " " $33,470 " " $(16,869)" " $100,000 " (a) "Lease income is recognized as 8.647% of the unrecovered investment at the beginning of each year in which the net investment is positive. The rate is that rate which, if applied to the net investment in the years in which the net investment is positive, will distribute the net income (net cash flow) to those years." (b) Each component is allocated among the years of positive net investment in proportion to the allocation of net income in column 4.

##### [842-50-55-10](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-10)

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Illustrative journal entries for the year ending December 31, 1975, follow.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-CC230BAB-6366-457C-B1CB-BF266472CE3C-low.gif)
    
    Lessor's Initial Investment Debit Credit "Rentals receivable (table in paragraph 842-50-55-8, total of column 1 minus residual value, minus totals of columns 3 and 6)" " $233,470 " "Investment tax credit receivable (table in paragraph 842-50-55-8, column 7)" " 100,000 " Estimated residual value (paragraph 842-50-55-7) " 200,000 " "Unearned and deferred income (table in paragraph 842-50-55-9, totals of columns 5 and 7)" " $133,470 " Cash " 400,000 " Record lessor's initial investment First Year of Operation Journal Entry 1 Cash " 15,565 " "Rentals receivable (table in paragraph 842-50-55-8, column 1 minus columns 3 and 6)" " 15,565 " Collection of first year's net rental Journal Entry 2 Cash (a) " 100,000 " "Investment tax credit receivable (table in paragraph 842-50-55-8, column 7)" " 100,000 " Receipt of investment tax credit Journal Entry 3 Unearned and deferred income " 9,929 " "Income from leveraged leases (table in paragraph 842-50-55-9, column 5)" " 9,929 " Recognition of first year's portion of pretax income allocated in the same proportion as the allocation of total income "(34,588 ÷ 116,601) × 33,470 = 9,929 " Journal Entry 4 Unearned and deferred income " 29,663 " "Investment tax credit recognized (table in paragraph 842-50-55-9, column 7)" " 29,663 " Recognition of first year's portion of investment tax credit allocated in the same proportion as the allocation of total income "(34,588 ÷ 116,601) × 100,000 = 29,663" Journal Entry 5 "Cash (table in paragraph 842-50-55-8, column 5) (a)" " 53,856 " "Income tax expense (table in paragraph 842-50-55-9, column 6)" " 5,004 " Deferred taxes " 58,860 " "To record receipt of first year's tax credit from lease operation, to charge income tax expense for tax effect of pretax accounting income, and to recognize as deferred taxes the tax effect of the difference between pretax accounting income and the tax loss for the year, calculated as follows:" "Tax loss (table in paragraph 842-50-55-8, column 4)" " $(106,857)" Pretax accounting income " 9,929 " Difference " $(116,786)" "Deferred taxes ($116,786 × 50.4%)" " $58,860 " (a) "Receipts of the investment tax credit and other tax benefits are shown as cash receipts for simplicity only. Those receipts probably would not be in the form of immediate cash inflow. Instead, they likely would be in the form of reduced payments of taxes on other income of the lessor or on the combined income of the lessor and other entities whose operations are joined with the lessor's operations in a consolidated tax return."

##### [842-50-55-11](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-11)

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The following are illustrative partial financial statements including notes.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-232D2D17-56C5-44BD-AAB3-FAE72480042A-low.gif)
    
    BALANCE SHEET ASSETS LIABILITIES "December 31," "December 31," 1976 1975 1976 1975 Investment in leveraged leases " $334,708 " " $324,027 " Deferred taxes arising from leveraged leases " $166,535 " " $58,860 "
    

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-46CBAE56-7799-402D-95A6-16CCD21B5BFA-low.gif)
    
    INCOME STATEMENT (Ignoring all income and expense items other than those relating to leveraged leasing) 1976 1975 Income from leveraged leases " $6,582 " " $9,929 " Income before taxes and investment tax credit " 6,582 " " 9,929 " Less: Income tax expense (a) " (3,317)" " (5,004)" " 3,265 " " 4,925 " Investment tax credit recognized (a) " 19,664 " " 29,663 " Net income " $22,929 " " $34,588 " (a) "These two items may be netted for purposes of presentation in the income statement, provided that the separate amounts are disclosed in a note to financial statements."
    

The following are notes to the illustrative financial statements included in this Example.

-   Investment in Leveraged Leases
-   Entity is the lessor in a leveraged lease agreement entered into in 1975 under which mining equipment having an estimated economic life of 18 years was leased for a term of 15 years. Entity's equity investment represented 40 percent of the purchase price; the remaining 60 percent was furnished by third-party financing in the form of long-term debt that provides for no recourse against Entity and is secured by a first lien on the property. At the end of the lease term, the equipment is turned back to Entity. The residual value at that time is estimated to be 20 percent of cost. For federal income tax purposes, Entity receives the investment tax credit and has the benefit of tax deductions for depreciation on the entire leased asset and for interest on the long-term debt. During the early years of the lease, those deductions exceed the lease rental income, and substantial excess deductions are available to be applied against Entity's other income. In the later years of the lease, rental income will exceed the deductions and taxes will be payable. Deferred taxes are provided to reflect this reversal. Entity's net investment in leveraged leases is composed of the following elements.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-41FA9B43-E031-4667-89B3-92679734C109-low.gif)
    
    "December 31," 1976 1975 Rentals receivable (net of principal and interest on the nonrecourse debt) " $202,340 " " $217,905 " Estimated residual value of leased assets " 200,000 " " 200,000 " Less: Unearned and deferred income " (67,632)" " (93,878)" Investment in leveraged leases " 334,708 " " 324,027 " Less: Deferred taxes arising from leveraged leases " (166,535)" " (58,860)" Net investment in leveraged leases " $168,173 " " $265,167 "

##### [842-50-55-12](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-12)

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Allocation of annual cash flow to investment and income follows, revised to include new residual value estimate.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-DD5345B2-7464-4853-B846-607992FF5E07-low.gif)
    
    Annual Cash Flow Components of Income Year Lessor's Net Investment at Beginning of Year Total Allocated to Investment Allocated to Income (a) Pretax Loss Tax Effect of Pretax Loss Investment Tax Credit 1 " $400,000 " " $169,421 " " $142,458 " " $26,963 " " $(16,309)" " $8,220 " " $35,052 " 2 " 257,542 " " 119,923 " " 102,563 " " 17,360 " " (10,501)" " 5,293 " " 22,568 " 3 " 154,979 " " 89,769 " " 79,323 " " 10,446 " " (6,319)" " 3,184 " " 13,581 " 4 " 75,656 " " 71,525 " " 66,425 " " 5,100 " " (3,085)" " 1,555 " " 6,630 " 5 " 9,231 " " 53,182 " " 52,560 " 622 (377) 190 809 6 " (43,329)" " 18,616 " " 18,616 " - - - - 7 " (61,945)" " (9,553)" " (9,553)" - - - - 8 " (52,392)" " (11,108)" " (11,108)" - - - - 9 " (41,284)" " (12,803)" " (12,803)" - - - - 10 " (28,481)" " (14,649)" " (14,649)" - - - - 11 " (13,832)" " (16,663)" " (16,663)" - - - - 12 " 2,831 " " (18,857)" " (19,048)" 191 (115) 58 248 13 " 21,879 " " (21,248)" " (22,723)" " 1,475 " (892) 450 " 1,917 " 14 " 44,602 " " (23,856)" " (26,862)" " 3,006 " " (1,819)" 916 " 3,909 " 15 " 71,464 " " (26,698)" " (31,515)" " 4,817 " " (2,914)" " 1,469 " " 6,262 " 16 " 102,979 " " 109,920 " " 102,979 " " 6,941 " " (4,199)" " 2,116 " " 9,024 " Totals " $476,921 " " $400,000 " " $76,921 " " $(46,530)" " $23,451 " " $100,000 " (a) The revised allocation rate is 6.741%.

##### [842-50-55-13](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-13)

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Balances in investment accounts before revised estimate of residual value follow.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-8984F43E-1B40-4351-8C53-B80FD11A6AE9-low.gif)
    
    1 2 3 4 5 6 7 "Unearned and Deferred Income" Rentals Receivable (a) Estimated Residual Value Investment Tax Credit Receivable Pretax Income (Loss) (b) Investment Tax Credit (c) Deferred Taxes (d) Net Investment (Col. 1+2+3) less (Col. 4 + 5 + 6) Initial investment " $233,470 " " $200,000 " " $100,000 " " $33,470 " " $100,000 " $- " $400,000 " Changes in year of operation 1 " (15,565)" - " (100,000)" " (9,929)" " (29,663)" " 58,860 " " (134,833)" 2 " (15,565)" - - " (6,582)" " (19,664)" " 107,675 " " (96,994)" 3 " (15,565)" - - " (4,174)" " (12,472)" " 76,308 " " (75,227)" 4 " (15,565)" - - " (2,307)" " (6,893)" " 57,123 " " (63,488)" 5 " (15,565)" - - (731) " (2,184)" " 37,985 " " (50,635)" 6 " (15,565)" - - - - " 3,051 " " (18,616)" 7 " (15,565)" - - - - " (25,118)" " 9,553 " 8 " (15,564)" - - - - " (26,672)" " 11,108 " 9 " (15,564)" - - - - " (28,367)" " 12,803 " 10 " (15,565)" - - - - " (30,214)" " 14,649 " "Balances, beginning of eleventh year" " $77,822 " " $200,000 " $- " $9,747 " " $29,124 " " $230,631 " " $8,320 " (a) "Table in paragraph 842-50-55-8, column 1, excluding residual value, minus columns 3 and 6." (b) "Table in paragraph 842-50-55-9, column 5." (c) "Table in paragraph 842-50-55-9, column 7." (d) 50.4% of difference between taxable income (loss) in column 4 of the table in paragraph 842-50-55-8 and pretax accounting income (loss) in column 5 of the table in paragraph 842-50-55-9.

##### [842-50-55-14](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-14)

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Illustrative journal entries involving a reduction in residual value follow.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-9C698711-4325-4D28-ADFF-3DAB1E04DE7B-low.gif)
    
    Debit Credit Journal Entry 1 Pretax income (or loss) " $60,314 " Unearned and deferred income " 27,450 " Pretax income (loss): Balance at end of tenth year " $9,747 " (a) Revised balance " (9,939)" (b) Adjustment " (19,686)" Deferred investment tax credit: Balance at end of tenth year " 29,124 " (c) Revised balance " 21,360 " (d) Adjustment " (7,764)" Investment tax credit recognized " $7,764 " Estimated residual value " 80,000 " To record: a. The cumulative effect on pretax income and the effect on future income resulting from the decrease in estimated residual value: Reduction in estimated residual value " $80,000 " Less portion attributable to future years (unearned and deferred income) " (19,686)" Cumulative effect (charged against current income) " $60,314 " b. The cumulative and future effect of the change in allocation of the investment tax credit resulting from the reduction in estimated residual value Journal Entry 2 Deferred taxes " 30,398 " Income tax expense " 30,398 " To recognize deferred taxes for the difference between pretax accounting income (or loss) and taxable income (or loss) for the effect of the reduction in estimated residual value: Pretax accounting loss per Journal Entry 1 " $(60,314)" Tax income (or loss) - Difference " $(60,314)" "Deferred taxes ($60,314 × 50.4%)" " $(30,398)" (a) "Table in paragraph 842-50-55-13, column 4." (b) "Table in paragraph 842-50-55-12, total of column 5 minus amounts applicable to the first 10 years." (c) "Table in paragraph 842-50-55-13, column 5." (d) "Table in paragraph 842-50-55-12, total of column 7 minus amounts applicable to the first 10 years."

##### [842-50-55-15](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-15)

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Adjustment of investment accounts for revised estimates of residual value follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-A9C0590E-588B-4930-87F7-E3156BA18F4F-low.gif)
    
    "Unearned and Deferred Income" Net Investment Rentals Receivable Estimated Residual Value Pretax Income (Loss) Investment Tax Credit Deferred Taxes (Col. 1 + 2) less (Col. 3 + 4 + 5) "Balances, beginning of eleventh year (table in paragraph 842-50-55-13)" " $77,822 " " $200,000 " " $9,747 " " $29,124 " " $230,631 " " $8,320 " "Adjustment of estimated residual value and unearned and deferred income (table in paragraph 842-50-55-14, Journal Entry 1)" - " (80,000)" " (19,686)" " (7,764)" - " (52,550)" "Adjustment of deferred taxes for the cumulative effect on pretax accounting income (table in paragraph 842-50-55-14, Journal Entry 2)" - - - - " (30,398)" " 30,398 " "Adjusted balances, beginning of eleventh year" " $77,822 " " $120,000 " " $(9,939)" " $21,360 " " $200,233 " " $(13,832)" (a) (a) "Table in paragraph 842-50-55-12, column 1."

##### [842-50-55-16](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-16)

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This Example illustrates integration of the results of a lessor's income tax accounting for leveraged leases (in accordance with the guidance in this Subtopic) with the other results of accounting for income taxes as required by Topic 740.

##### [842-50-55-17](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-17)

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At the end of Year 1 (the current year), an entity has two temporary differences.

##### [842-50-55-18](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-18)

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The first temporary difference is for a leveraged lease that was entered into in a prior year. During Year 1, the enacted tax rate for Year 2 and thereafter changes from 40 percent to 35 percent.

##### [842-50-55-19](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-19)

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After adjusting for the change in estimated total net income from the lease as a result of the change in tax rates, the components of the investment in the leveraged lease at the end of Year 1 are as follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-F4C4BF12-88B0-471E-8509-A73A2CAC66D7-low.gif)
    
    Net rentals receivable plus residual value minus unearned pretax income " $150,000 " Reduced by: Deferred investment tax credit " $9,000 " Deferred tax credits " 39,000 " " 48,000 " Net investment in leveraged lease for financial reporting " $102,000 "

##### [842-50-55-20](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-20)

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The second temporary difference is a $120,000 estimated liability for warranty expense that will result in a tax deduction in Year 5 when the liability is expected to be paid. Absent consideration of the deferred tax credits attributable to the leveraged lease, the weight of available evidence indicates that a valuation allowance is needed for the entire amount of the deferred tax asset related to that $120,000 deductible temporary difference.

##### [842-50-55-21](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-21)

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The tax basis of the investment in the leveraged lease at the end of Year 1 is $41,000. The amount of the deferred tax liability for that leveraged lease that would otherwise result from the application of guidance in Topic 740 on income taxes is determined as follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-19BEB619-A8E0-4F8A-A7D5-EFF48DCD5776-low.gif)
    
    Net rentals receivable plus residual value minus unearned pretax income " $150,000 " Temporary difference for deferred investment tax credit " 9,000 " " 141,000 " Tax basis of leveraged lease " 41,000 " Temporary difference " $100,000 " Deferred tax liability (35 percent) " $35,000 "

##### [842-50-55-22](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-22)

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Loss carryback (to Year 2) and loss carryforward (to Year 20) of the $120,000 tax deduction for warranty expense in Year 5 would offset the $100,000 of taxable amounts resulting from future recovery of the net investment in the leveraged lease over the remainder of the lease term.

##### [842-50-55-23](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-23)

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At the end of Year 1, the entity recognizes a $42,000 ($120,000 at 35 percent) deferred tax asset and a related $7,000 valuation allowance. The effect is to recognize a $35,000 net deferred tax benefit for the reduction in deferred tax credits attributable to the leveraged lease. Deferred tax credits attributable to the leveraged lease determined under the guidance in this Subtopic are $39,000. However, the deferred tax liability determined is only $35,000. The $4,000 difference is not available for offsetting.

##### [842-50-55-24](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-24)

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This Example illustrates how (in accordance with the guidance in paragraph [842-50-35-13](https://asc.understandingaccounting.org/asc/842/50/#842-50-35-13) and other paragraphs) a lessor would include advance payments and deposits in a recalculation of a leveraged lease resulting from a determination by the lessor that it would enter into a settlement of a tax position arising from a leveraged lease.

##### [842-50-55-25](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-25)

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This Example assumes that the lessor has concluded that the position originally taken on the tax return would meet the more-likely-than-not threshold in Subtopic 740-10 on income taxes. It also assumes that the lessor would conclude that the estimate of $50 for the projected lease-in, lease-out settlement is consistent with the measurement guidance in that Subtopic.

##### [842-50-55-26](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-26)

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A lessor makes an advance payment of $25 on July 1, 2007, $10 of which is estimated to be associated with issues arising from a lease-in, lease-out transaction. On July 1, 2007, the lessor changes its assumption about the timing of the tax cash flows and projects a settlement with the Internal Revenue Service on September 1, 2009. The projected settlement would result in a payment to the taxing authority of $125 of which $50 is associated with the lease-in, lease-out transaction. On July 1, 2007, when the lessor recalculates the leveraged lease, the lessor would include a $50 cash flow on September 1, 2009, as a projected outflow in the leveraged lease recalculation.

##### [842-50-55-27](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-27)

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This Example illustrates one way that a lessor's investment in a leveraged lease might be valued by the acquiring entity in a business combination or an acquisition by a not-for-profit entity and the subsequent accounting for the investment in accordance with the guidance in this Subtopic. The elements of accounting and reporting illustrated for this Example are as follows:

1.  a
    
    Acquiring entity's cash flow analysis by years (see paragraph [842-50-55-29](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-29))
    
2.  b
    
    Acquiring entity's valuation of investment in the leveraged lease (see paragraph [842-50-55-30](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-30))
    
3.  c
    
    Acquiring entity's allocation of annual cash flow to investment and income (see paragraph [842-50-55-31](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-31))
    
4.  d
    
    Journal entry for recording allocation of purchase price to net investment in the leveraged lease (see paragraph [842-50-55-32](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-32))
    
5.  e
    
    Journal entries for the year ending December 31, 1984 (Year 10 of the lease) (see paragraph [842-50-55-33](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-33)).

##### [842-50-55-28](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-28)

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This Example has the following terms and assumptions.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-38F4A110-5FDC-43C8-9628-C3C7CE1D17A2-low.gif)
    
    Cost of leased asset (equipment) "$1,000,000" Lease term "15 years, dating from January 1, 1975" Lease rental payments "$90,000 per year (payable last day of each year)" Residual value "$200,000 estimated to be realized 1 year after lease termination" Financing: Equity investment by lessor "$400,000" Long-term nonrecourse debt "$600,000, bearing interest at 9% and repayable in annual installments (on last day of each year) of $74,435.30" Depreciation allowable to lessor for income tax purposes "7-year asset depreciation range life using double-declining-balance method for the first 2 years (with the half-year convention election applied in the first year) and sum-of-years digits method for remaining life, depreciated to $100,000 salvage value" Lessor's income tax rate (federal and state) 50.4% (assumed to continue in existence throughout the term of the lease) Investment tax credit "10% of equipment cost or $100,000 (realized by the lessor on last day of first year of lease)" Initial direct costs "For simplicity, initial direct costs have not been included in the illustration" Date of business combination "January 1, 1982" Nontaxable transaction Tax status of business combination Appropriate interest rate for valuing net-of-tax return on investment 4½%

##### [842-50-55-29](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-29)

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Acquiring entity's cash flow analysis by years follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-C465A644-8FE0-41A2-B8D5-658A76FD7D0D-low.gif)
    
    1 2 3 4 5 6 7 Year Gross Lease Rentals and Residual Value Depreciation (for Income Tax Purposes) Loan Interest Payments "Taxable Income (Col. 1 - 2 - 3)" Income Tax (Charges) (Col. 4 × 50.4%) Loan Principal Payments Annual Cash Flow (Col. 1 - 3 + 5 - 6) 8 " $90,000 " - " $37,079 " " $52,921 " " $(26,672)" " $37,357 " " $(11,108)" 9 " 90,000 " - " 33,717 " " 56,283 " " (28,367)" " 40,719 " " (12,803)" 10 " 90,000 " - " 30,052 " " 59,948 " " (30,214)" " 44,383 " " (14,649)" 11 " 90,000 " - " 26,058 " " 63,942 " " (32,227)" " 48,378 " " (16,663)" 12 " 90,000 " - " 21,704 " " 68,296 " " (34,421)" " 52,732 " " (18,857)" 13 " 90,000 " - " 16,957 " " 73,043 " " (36,813)" " 57,478 " " (21,248)" 14 " 90,000 " - " 11,785 " " 78,215 " " (39,420)" " 62,651 " " (23,856)" 15 " 90,000 " - " 6,145 " " 83,855 " " (42,263)" " 68,290 " " (26,698)" 16 " 200,000 " " $100,000 " - " 100,000 " " (50,400)" - " 149,600 " Totals " $920,000 " " $100,000 " " $183,497 " " $636,503 " " $(320,797)" " $411,988 " " $3,718 "

##### [842-50-55-30](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-30)

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Acquiring entity's valuation of investment in the leveraged lease follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-CD0AB67A-1BF2-4AE9-BB83-7FDF8E1CA1E8-low.gif)
    
    Cash Flow Present Value at 4½% Net-of-Tax Rate "1. Rentals receivable (net of principal and interest on the nonrecourse debt) ($15,564.70 at the end of each year for 8 years)" " $102,663 " "2. Estimated residual value ($200,000 realizable at the end of 9 years)" " 134,581 " "3. Future tax payments (various amounts payable over 9 years—see the table in paragraph 842-50-55-29)" " (253,489)" Net present value " $(16,245)"

##### [842-50-55-31](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-31)

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Source downloaded (UTC): 2026-09-10T01:58:27.334Z to 2026-09-10T01:58:27.334Z

Record version: sha256:6f464e500039e00fa1af6c1678d91f38846f2fa87797dffe22f35a7c6534c124

Snapshot version: sha256:15aea8165dff9f5ae47d9484f8470588b13b307f56e1d50801bf4d85ec190e3f

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Acquiring entity's allocation of annual cash flow to investment and income follows (see footnote (a)).

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-E7FE62DD-2993-4EDA-9423-FA85FB059F2E-low.gif)
    
    1 2 3 4 5 6 Annual Cash Flow Components of Income (b) Year Net Investment at Beginning of Year "Total from Col. 7 of the Table in Paragraph 842-50-55-29" Allocated to Investment Allocated to Income (a) Pretax Income Tax Effect of Pretax Income 8 " $(16,245)" " $(11,108)" " $(11,108)" - - - 9 " (5,137)" " (12,803)" " (12,803)" - - - 10 " 7,666 " " (14,649)" " (14,973)" $324 " $5,530 " " $(5,206)" 11 " 22,639 " " (16,663)" " (17,621)" 958 " 16,353 " " (15,395)" 12 " 40,260 " " (18,857)" " (20,561)" " 1,704 " " 29,087 " " (27,383)" 13 " 60,821 " " (21,248)" " (23,822)" " 2,574 " " 43,937 " " (41,363)" 14 " 84,643 " " (23,856)" " (27,439)" " 3,583 " " 61,160 " " (57,577)" 15 " 112,082 " " (26,698)" " (31,443)" " 4,745 " " 80,995 " " (76,250)" 16 " 143,525 " " 149,600 " " 143,525 " " 6,075 " " 103,698 " " (97,623)" Totals " $3,718 " " $(16,245)" " $19,963 " " $340,760 " " $(320,797)" (a) "Lease income is recognized as 4.233% of the unrecovered investment at the beginning of each year in which the net investment is positive. The rate is that rate which, if applied to the net investment in the years in which the net investment is positive, will distribute the net income (net cash flow) to those years. " (b) Each component is allocated among the years of positive net investment in proportion to the allocation of net income in column 4. Journal Entry 2 in the table in paragraph 842-50-55-33 includes an example of this computation.

##### [842-50-55-32](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-32)

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Source downloaded (UTC): 2026-09-10T01:58:27.334Z to 2026-09-10T01:58:27.334Z

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Illustrative journal entry for recording allocation of purchase price to net investment in the leveraged lease follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-4BC264A3-CF91-474D-AB2B-C542957B07B8-low.gif)
    
    "Rentals receivable (table in paragraph 842-50-55-29, total of column 1 minus residual value, minus totals of columns 3 and 6)" " $124,515 " Estimated residual value (paragraph 842-50-55-28) " 200,000 " "Purchase price allocation clearing account (paragraph 842-50-55-30, present value)" " 16,245 " "Unearned and deferred income (paragraph 842-50-55-30, present value, minus total of rentals receivable and estimated residual value)" " $340,760 "

##### [842-50-55-33](https://asc.understandingaccounting.org/asc/842/50/#842-50-55-33)

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Source downloaded (UTC): 2026-09-10T01:58:27.334Z to 2026-09-10T01:58:27.334Z

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Illustrative journal entries for year ending December 31, 19Y4, follows.

-   ![ ](https://asc.understandingaccounting.org/asc-img/GUID-10B02688-1D77-4318-AFC8-08357D54A1ED-low.gif)
    
    "Third Year of Operation after the Business Combination (Year 10 of the Lease)" Journal Entry 1 Cash " $15,565 " "Rentals receivable (table in paragraph 842-50-55-29, column 1 minus columns 3 and 6)" " $15,565 " Collection of year's net rental Journal Entry 2 Unearned and deferred income " $5,530 " "Income from leveraged leases (table in paragraph 842-50-55-31, column 5)" " $5,530 " Recognition of pretax income for the year allocated in the same proportion as the allocation of total income computed as follows: "(\[$324 ÷ $19,963\] × $340,760 = $5,530)" Journal Entry 3 "Deferred taxes (table in paragraph 842-50-55-29, column 5, minus table in paragraph 842-50- 55-31, column 6)" " $25,008 " "Income tax expense (table in paragraph 842-50- 55-31, column 6)" " 5,206 " "Cash (table in paragraph 842-50-55-29, column 5)" " $30,214 " To record payment of tax for the year