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Chapter 21: Q21-7E-c (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.)

(c) Prepare all the necessary journal entries for Flynn for 2017.

Short Answer

Expert verified

Answer

Lease Liability is $141,846

Accumulated depreciation is $23,641

Interest Payable is $13,325

Step by step solution

01

Meaning of Lessor

The lessor is the owner of the asset who gives the lessee the right to use the property on lease. The lessee makes payments in accordance with the agreement made between the lessor and the lessee.

02

Preparing Journal Entries for Flynn

Date

Particular

Debit ($)

Credit ($)

January 1, 2017

Leased Equipment

141,846

Lease Liability

141,846

January 1, 2017

Lease Liability

30,804

Cash

30,804

Working Notes:

Calculation of Lease Liability

尝别补蝉迟濒颈补产颈濒颈迟测=础苍苍耻补濒谤别苍迟补濒辫补测尘别苍迟蝉脳辫谤别蝉别苍迟惫补濒耻别辞蹿补苍苍耻颈迟测=$30,804脳4.60478=$141,846

Note: - Present value of an annuity due at 12% for 6 periods

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Most popular questions from this chapter

(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

(b) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2018, by Ludwick. (Prepare the lease amortization schedule for all five payments.)

(Lessor Entries; Direct-Financing Lease with Option to Purchase) Castle Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Jan Way Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement:

  1. Jan Way Company has the option to purchase the equipment for \(16,000 upon termination of the lease.
  2. The equipment has a cost and fair value of \)160,000 to Castle Leasing Company. The useful economic life is 2 years, with a salvage value of \(16,000.
  3. Jan Way Company is required to pay \)5,000 each year to the lessor for executory costs.
  4. Castle Leasing Company desires to earn a return of 10% on its investment.
  5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(b) Assuming that Jan Way Company exercises its option to purchase the equipment on December 31, 2018, prepare the journal entry to reflect the sale on Castle鈥檚 books.

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

(b) Prepare the journal entry or entries that should be recorded on January 1, 2017, by Cage Company.

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.

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?
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