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Chapter 21: Q21-2P-c (page 1245)

Question: (Lessee-Lessor Entries, Operating Lease) Cleveland Inc. leased a new crane to Abriendo Construction under a 5-year noncancelable contract starting January 1, 2017. Terms of the lease require payments of \(33,000 each January 1, starting January 1, 2017. Cleveland will pay insurance, taxes, and maintenance charges on the crane, which has an estimated life of 12 years, a fair value of \)240,000, and a cost to Cleveland of \(240,000. The estimated fair value of the crane is expected to be \)45,000 at the end of the lease term. No bargain-purchase or -renewal options are included in the contract. Both Cleveland and Abriendo adjust and close books annually at December 31. Collectibility of the lease payments is reasonably certain, and no uncertainties exist relative to unreimbursable lessor costs. Abriendo鈥檚 incremental borrowing rate is 10%, and Cleveland鈥檚 implicit interest rate of 9% is known to Abriendo.

Instructions

(c) Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2017.

Short Answer

Expert verified

Answer

Abriendo must disclose rent expenditure.

Cleveland must disclose the leased crane and the accumulated depreciation.

Step by step solution

01

Meaning of Lease agreement

A lease arrangement refers to a lease contract recognizing a similar arrangement for a specified period in which the lessee is expected to pay the lessee, in whole or in part, the use of a piece of the lease for a specified period in lieu of payment time it goes.

02

Explaining the item that should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor

Abriendo, as lessee, must declare in the income statement the $33,000 in rent expenditure and the future minimum rental payments necessary as of January 1 (in total, $132,000) and for each of the next four years: 2018鈥�$33,000; 2019鈥�$33,000; 2020鈥�$33,000; 2021鈥�$33,000. This lease would have no effect on the lessee's financial sheet.

Cleveland, as lessor, must separately report the cost of the rented crane ($240,000) and the accrued depreciation of $18,750 from assets not leased in the balance sheet or in the notes. Furthermore, Cleveland must disclose in the notes the minimum future rentals as a total of $132,000, as well as for each of the next four years: 2018鈥�$33,000; 2019鈥�$33,000; 2020鈥�$33,000; 2021鈥�$33,000.

The lessor's income statement shows rent revenue as well as costs for insurance, property taxes, maintenance and repairs, and depreciation.

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Most popular questions from this chapter

(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

(c) Prepare all of the lessor鈥檚 journal entries for the first year.

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

(e) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2017. (Prepare a lease amortization schedule for 2 years.)

The following are four independent situations.

(c) On January 1, 2017, McKane Corp. sold an airplane with an estimated useful life of 10 years. At the same time, McKane leased back the plane for 10 years. The sales price of the airplane was \(500,000, the carrying amount \)379,000, and the annual rental $73,975.22. McKane Corp. intends to depreciate the leased asset using the sum-of-the-years鈥�-digits depreciation method. Discuss how the gain on the sale should be reported at the end of 2017 in the financial statements.

What are 鈥渋nitial direct costs鈥� and how are they accounted for?

(Lessee Entries and Balance Sheet Presentation, Capital Lease) Ludwick Steel Company as lessee signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of \(40,000 are to be made at the beginning of each lease year (December 31). The taxes, insurance, and the maintenance costs are the obligation of the lessee. The interest rate used by the lessor in setting the payment schedule is 9%; Ludwick鈥檚 incremental borrowing rate is 10%. Ludwick is unaware of the rate being used by the lessor. At the end of the lease, Ludwick has the option to buy the equipment for \)1, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Ludwick uses the straight-line method of depreciation on similar owned equipment.

Instructions

(d) What amounts would appear on Ludwick鈥檚 December 31, 2019, balance sheet relative to the lease arrangement?
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