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Chapter 21: 4CA_1(b) (page 1251)

Question: (Comparison of Different Types of Accounting by Lessee and Lessor)

Part 1: Capital leases and operating leases are the two classifications of leases described in FASB pronouncements from the standpoint of the lessee.

Instructions

(b) Describe how an operating lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming equal monthly payments are made by the lessee at the beginning of each month of the lease. Describe the change in accounting, if any, when rental payments are not made on a straight-line basis.

Do not discuss the criteria for distinguishing between capital leases and operating leases.

Short Answer

Expert verified

Answer

No asset or liability would be recorded at the inception of the lease.

Step by step solution

01

 Step 1: Meaning of Operating lease

An operating lease is when a lessor rents an asset to a lessee without transferring ownership of the asset to the lessee. The lessee normally enjoys unfettered use of the item throughout the rental time but is responsible for the asset's condition when it is returned to the lessor at the conclusion of the lease.

02

Explaining how an operating lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease

At the beginning of the lease, no asset or obligation would be documented. Normally, rent on an operating lease would be charged to expenditure as it became due during the lease term. Rent expense would be recognized on a straight-line basis even if rent payments were not made on a straight-line basis unless another systematic or rational basis is more representative of the time pattern in which use benefit is derived from the leased property, in which case that basis would be used.

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Most popular questions from this chapter

(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.

  1. The lease arrangement is for 10 years.
  2. The leased building cost \(4,500,000 and was purchased for cash on January 1, 2017.
  3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
  4. Lease payments are \)275,000 per year and are made at the end of the year.
  5. Property tax expense of \(85,000 and insurance expense of \)10,000 on the building were incurred by Nelson in the first year. Payment on these two items was made at the end of the year.
  6. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

(b) Prepare the journal entries that Wise Inc. should make in 2017

Use the information for IBM from BE21-6. Assume the direct-financing lease was recorded at a present value of \(150,000. Prepare IBM鈥檚 December 31, 2017, entry to record interest.

Assume that IBM leased equipment that was carried at a cost of \)150,000 to Sharon Swander Company. The term of the lease is 6 years beginning January 1, 2017, with equal rental payments of \(30,044 at the beginning of each year. All executory costs are paid by Swander directly to third parties. The fair value of the equipment at the inception of the lease is \)150,000. The equipment has a useful life of 6 years with no salvage value. The lease has an implicit interest rate of 8%, no bargain-purchase option, and no transfer of title. Collectibility is reasonably assured with no additional cost to be incurred by IBM. Prepare IBM鈥檚 January 1, 2017, journal entries at the inception of the lease.

How should changes in the estimated unguaranteed residual value be handled by the lessor?

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

  1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
  2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
  3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
  4. Cole Company assumes direct responsibility for all executory costs.
  5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
  6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(c) Prepare all of the journal entries for the lessor for 2017 and 2018 to record the lease agreement, the receipt of lease payments, and the recognition of income. Assume the lessor鈥檚 annual accounting period ends on December 31.

Alice Foyle, M.D. (lessee), has a noncancelable 20-year lease with Brownback Realty, Inc. (lessor) for the use of a medical building. Taxes, insurance, and maintenance are paid by the lessee in addition to the fixed annual payments, of which the present value is equal to the fair value of the leased property. At the end of the lease period, title becomes the lessee鈥檚 at a nominal price. Considering the terms of the lease described above, comment on the nature of the lease transaction and the accounting treatment that should be accorded it by the lessee.
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