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Chapter 21: 3CA_c (page 1251)

Question: (Lessee Capitalization Criteria) On January 1, Santiago Company, a lessee, entered into three noncancelable leases for brand-new equipment, Lease L, Lease M, and Lease N. None of the three leases transfers ownership of the equipment to Santiago at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, is 75% of the fair value of the equipment.

The following information is peculiar to each lease.

  1. Lease L does not contain a bargain-purchase option. The lease term is equal to 80% of the estimated economic life of the equipment.
  2. Lease M contains a bargain-purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.
  3. Lease N does not contain a bargain-purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

Instructions

(c) Assuming that the minimum lease payments are made on a straight-line basis, how should Santiago record each minimum lease payment for each of the three leases above?

Short Answer

Expert verified

Answer

Minimum lease payment should be recorded for L and M between a reduction of the liability and interest expense and for N rental expense as they become payable.

Step by step solution

01

Meaning of Straight-line basis

Straight-line" approaches allow expenditures to be dispersed equally across a set period of time. Straight-line depreciation indicates that an asset's value drops gradually during its useful life, rather than unevenly as in a bell-curve type model.

02

Explaining how Santiago should record each lease payments

For Lease L, Santiago Company should divide each minimum lease payment between liability reduction and interest expenditure, resulting in a constant monthly rate of interest on the obligation's remaining balance.

Santiago Company should assign each minimum lease payment in the same way that it did for Lease L for Lease M.

Santiago Company shall charge minimum lease (rental) payments when they become due to rental expenditure for Lease N.

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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.

(Lessee Computations and Entries, Capital Lease with Guaranteed Residual Value) Assume the same data as in P21-13 and that Chambers Medical Center has an incremental borrowing rate of 10%.

Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is \(411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be \)15,000. The hospital will pay rents of \(60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of \)250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.

Instructions

b) Prepare a 10-year lease amortization schedule.

Callaway Golf Co. leases telecommunications equipment. Assume the following data for equipment leased from Photon Company. The lease term is 5 years and requires equal rental payments of \(31,000 at the beginning of each year. The equipment has a fair value at the inception of the lease of \)138,000, an estimated useful life of 8 years, and no residual value.

Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain-purchase option. How should Callaway classify this lease?

Use the information for Indiana Jones Corporation from BE21-9. Assume that for Lost Ark Company, the lessor, collectibility is reasonably predictable, there are no important uncertainties concerning costs, and the carrying amount of the equipment is \(202,921. Prepare Lost Ark鈥檚 January 1, 2017, journal entries.

Indiana Jones Corporation enters into a 6-year lease of equipment on January 1, 2017, which requires 6 annual payments of \)40,000 each, beginning January 1, 2017. In addition, Indiana Jones guarantees the lessor a residual value of $20,000 at lease-end. The equipment has a useful life of 6 years. Prepare Indiana Jones鈥� January 1, 2017, journal entries assuming an interest rate of 10%.

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

(2) Sales price.
See all solutions

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