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Chapter 21: Q21-7E-b (page 1242)

Question: (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.

  1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
  2. Equal rental payments are due on January 1 of each year, beginning in 2017.
  3. The fair value of the equipment on January 1, 2017, is \(150,000, and its cost is \)120,000.
  4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Flynn depreciates all of its equipment on a straight-line basis.
  5. Bensen set the annual rental to ensure an 11% rate of return. Flynn鈥檚 incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
  6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.

Instructions

(Both the lessor and the lessee鈥檚 accounting period ends on December 31.)

(b) Calculate the amount of the annual rental payment.

Short Answer

Expert verified

Answer

Rental Payments are $30,804.

Step by step solution

01

Meaning of Rental payments

Rental payment is a payment made by one tenant in exchange for the right to occupy or use another's property at predetermined intervals, usually in an amount established by contract.

02

Calculating the amount of the annual rental payment

Computation of annual rental payment

Rentalpayments=Fairvalueofequipment-(unguarenteedresidualvalue脳presentvalue)presentvalueofannuity=$150,000$10,000脳0.534644,69590=$150,000-5,346.44,69590=$30,804

Note:

Present value of $1 at 11% for 6 periods

Present value of an annuity due at 11% for 6 periods.

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Most popular questions from this chapter

Question: (Balance Sheet and Income Statement Disclosure鈥擫essee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017

\(300,383

Residual value at end of lease term

鈥�0鈥�

Lessor鈥檚 implicit rate

10%

Lessee鈥檚 incremental borrowing rate

10%

Annual lease payment due at the beginning of each year, beginning with October 1, 2017

\)62,700

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to \(5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This \)5,500 is not included in the rental payment of \(62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.

Date

Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?

Receivable

Balance of Lease Liability/Receivable

10/01/17

\)300,383

10/01/17

\(62,700

\)62,700

237,683

10/01/18

\(62,700

\)23,768

38,932

198,751

10/01/19

\(62,700

19,875

42,825

155,926

10/01/20

\)62,700

15,593

47,107

108,819

10/01/21

\(62,700

10,882

51,818

57,001

10/01/22

\)62,700

5,699*

57,001

0

\(376,200

\)75,817

\(300,383

*Rounding error is \)1.

(b) Assuming the lessee鈥檚 accounting period ends on December 31, answer the following questions with respect to this lease agreement.

(3) What items and amounts will appear on the lessee鈥檚 income statement for the year ending December 31, 2018?

Assume that on January 1, 2017, Kimberly-Clark Corp. signs a 10-year noncancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement. 1. The agreement requires equal rental payments of \(72,000 beginning on January 1, 2017. 2. The fair value of the building on January 1, 2017, is \)440,000. 3. The building has an estimated economic life of 12 years, with an unguaranteed residual value of \(10,000. Kimberly-Clark depreciates similar buildings on the straight-line method. 4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor. 5. Kimberly-Clark鈥檚 incremental borrowing rate is 12% per year. The lessor鈥檚 implicit rate is not known by Kimberly-Clark. 6. The yearly rental payment includes \)2,471 of executory costs related to taxes on the property.

Instructions

Prepare the journal entries on the lessee鈥檚 books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. Kimberly-Clark鈥檚 corporate year-end is December 31.

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%.

Metheny Corporation鈥檚 lease arrangements qualify as sales-type leases at the time of entering into the transactions. How should the corporation recognize revenues and costs in these situations?

(Lessee Accounting and Reporting) On January 1, 2017, Evans Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Evans by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2017, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Instructions

(c) What expenses related to this lease will Evans incur during the first year of the lease, and how will they be determined?
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