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Chapter 21: Q7Q (page 1239)
Outline the accounting procedures involved in applying the operating method by a lessee.
A lessee's rent expense accrues day by day while the property is utilized under the operational method.
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(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
(a) What is the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized by the lessee? Do not discuss the specific criteria for classifying a specific lease as a capital lease.
(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?
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.
(1) What items and amounts will appear on the lessee鈥檚 income statement for the year ending December 31, 2017?
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.
Instructions
(a) Assuming the lessee鈥檚 accounting period ends on September 30, 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 September 30, 2019?
(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
(c) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2019, by Ludwick.
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