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Chapter 21: 20Q (page 1239)

What is the nature of a 鈥渟ale-leaseback鈥� transaction?

Short Answer

Expert verified

The purpose of the transaction is to raise money with a certain property given as security.

Step by step solution

01

Meaning of sale-leaseback

The term "sell-leaseback" refers to an exchange in which the owner of an asset offers such an asset to another and quickly leases it back from the unused owner. The asset is sold at a price equal to or less than the current fair value and is rented back for the period of estimating the asset's valuable life for instalments of the lease, to reimburse the buyer, the money also paid by the buyer contributed a sensible return to speculation.

02

Explaining the nature of a “sale-leaseback” transaction

The goal of the transaction is to raise funds using a particular asset as collateral. For accounting reasons, the lessor must account for the sale-leaseback as a capital lease if the conditions are met, and the lessee should account for it as a purchase and as a direct-financing lease if the criteria are met.

Any revenue received by the seller-lessee from the sale of the leased asset must be deferred and amortized during the term of the lease (or economic life if any of the criteria are not met).

  1. A bargaining option is exercised in proportion to the amortization of the leased asset or
  2. There is a transfer of ownership at the conclusion of the lease. Damage should be reported as soon as possible. In addition, the marginal leaseback (rent with a present value of less than 10% of fair value) must be recorded as a sale recognizing the profit.

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Most popular questions from this chapter

On January 1, 2017, Irwin Animation sold a truck to Peete Finance for \(33,000 and immediately leased it back. The truck was carried on Irwin鈥檚 books at \)28,000. The term of the lease is 5 years, and title transfers to Irwin at lease-end. The lease requires five equal rental payments of $8,705 at the end of each year. The appropriate rate of interest is 10%, and the truck has a useful life of 5 years with no salvage value. Prepare Irwin鈥檚 2017 journal entries.

Outline the accounting procedures involved in applying the operating method by a lessor.

Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston鈥檚 specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

Winston鈥檚 incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is \)2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Instructions

(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.

Question: (Lessee Entries and Balance Sheet Presentation, Capital Lease) On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of \(137,899 (including the executory costs of \)6,000) at the beginning of each year, starting January 1, 2017. The taxes, the insurance, and the maintenance, estimated at \(6,000 a year, are the obligations of the lessee. The leased equipment is to be capitalized at \)550,000. The asset is to be depreciated on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage鈥檚 incremental borrowing rate is 12%, and the implicit rate in the lease is 10%, which is known by Cage. Title to the equipment transfers to Cage when the lease expires. The asset has an estimated useful life of 5 years and no residual value.

Instructions

(e) Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made.

Walker Company is a manufacturer and lessor of computer equipment. What should be the nature of its lease arrangements with lessees if the company wishes to account for its lease transactions as sales-type leases?
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