CH 21 Answer To in Class Diiscussion Problems [PDF]

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Ch. 21 Leases In Class Discussion 15th ed P21-1, P21-4, E21-11 and E21-12 P21- 1 ( Lessee- Lessor Entries, Sales- Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2014. The following information relates to the lease agreement. 1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2. The cost of the machinery is $ 525,000, and the fair value of the asset on January 1, 2014, is $700,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight- line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2014. 5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. Instructions ( Assume the accounting period ends on December 31.) ( a) Discuss the nature of this lease for both the lessee and the lessor. ( b) Calculate the amount of the annual rental payment required. ( c) Compute the present value of the minimum lease payments. ( d) Prepare the journal entries Jensen would make in 2014 and 2015 related to the lease arrangement. 1



( e) Prepare the journal entries Glaus would make in 2014 and 2015.



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PROBLEM 21-1 (a) This is a capital lease to Jensen since the lease term is greater than 75% of the economic life of the leased asset. The lease term is 78% (7 ÷ 9) of the asset’s economic life. This is a capital lease to Glaus because collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is greater than 75% of the asset’s economic life. Since the fair value ($700,000) of the equipment exceeds the lessor’s cost ($525,000), the lease is a sales-type lease. (b) Calculation of annual rental payment: $700,000 – ($100,000 X .51316)* 5.35526**



= $121,130



**Present value of $1 at 10% for 7 periods. **Present value of an annuity due at 10% for 7 periods. (c) Computation of present value of minimum lease payments: PV of annual payments:$121,130 X 5.23054** = PV of guaranteed residual value:$100,000 X .48166** = 48,166 **Present value of an annuity due at 11% for 7 periods. **Present value of $1 at 11% for 7 periods.



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(d) 1/1/14 681,741



121,130 12/31/14



83,106



61,667 1/1/15 121,130 12/31/15 83,106



55,126



Leased Equipment................................ Lease Liability...............................



681,741



Lease Liability....................................... Cash...............................................



121,130



Depreciation Expense.......................... Accumulated Depreciation— Capital Leases ($681,741 – $100,000) ÷ 7..........



83,106



Interest Expense................................... Interest Payable ($681,741 – $121,130) X .11......



61,667



Lease Liability....................................... Interest Payable.................................... Cash...............................................



59,463 61,667



Depreciation Expense.......................... Accumulated Depreciation— Capital Leases..........................



83,106



Interest Expense................................... Interest Payable.............................



55,126



[($681,741 – $121,130 – $59,463) X .11]



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ACC 326: You will NOT be Tested on the Journal Entries for the Lessor (e) 1/1/14 700,000 525,000 121,130 12/31/14 57,887 1/1/15 63,243 57,887 12/31/15



51,563



Lease Receivable.................................. Cost of Goods Sold.............................. Sales Revenue...............................



700,000 525,000



Inventory........................................ Cash....................................................... Lease Receivable..........................



121,130



Interest Receivable............................... Interest Revenue [($700,000 – $121,130) X .10]....



57,887



Cash....................................................... Lease Receivable..........................



121,130



Interest Receivable....................... Interest Receivable............................... Interest Revenue ($700,000 – $121,130 – $63,243) X .10...............................



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51,563



P21- 4 ( Balance Sheet and Income Statement Disclosure— Lessee) The following facts pertain to a non-cancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system. Inception date October 1, 2014 Lease term 6 years Economic life of leased equipment 6 years Fair value of asset at October 1, 2014 $ 300,383 Residual value at end of lease term – 0– Lessor’s implicit rate 10% Lessee’s incremental borrowing rate 10% Annual lease payment due at the beginning of each year, beginning with October 1, 2014 $ 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, 2042. ( 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.



Annual Lease Balance of Payment/ Date Receipt Receivable 10/ 01/ 14 10/ 01/ 14 $ 62,700



Interest ( 10%)



Reduction



on Unpaid of Lease Lease Liability/ Receivable Liability/ Receivable Liability/ $ 62,700



$ 300,383 237,683 198,751 155,926 108,819 57,001



10/ 01/ 15 10/ 01/ 16 10/ 01/ 17 10/ 01/ 18



62,700 62,700 62,700 62,700



$ 23,768 19,875 15,593 10,822



38,932 42,825 47,107 51,818



10/ 01/ 19



62,700 $ 376,200



5,699* $ 75,817



57,001 $ 300,383



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– 0–



* Rounding error is $ 1. Instructions ( Round all numbers to the nearest cent.) ( a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2015? ( 2) What items and amounts will appear on the lessee’s balance sheet at September 30, 2015? ( 3) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2016? ( 4) What items and amounts will appear on the lessee’s balance sheet at September 30, 2016?



( b) Assuming the lessee’s 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’s income statement for the year ending December 31, 2014? ( 2) What items and amounts will appear on the lessee’s balance sheet at December 31, 2014? ( 3) What items and amounts will appear on the lessee’s income statement for the year ending December 31, 2015? ( 4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2015?



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PROBLEM 21-4



( a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2015? (a) 1.$ 23,768 $ 5,500 $ 50,064



Interest expense (See amortization schedule) Lease executory expense Depreciation expense ($300,383 ÷ 6 = $50,064)



( a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 2) What items and amounts will appear on the lessee’s balance sheet at September 30, 2015?



2.



$ 38,932 $ 23,768



Current liabilities: Lease liability Interest payable



$198,751



Long-term liabilities: Lease liability



$300,383 ($50,064)



Property, plant, and equipment: Leased equipment Acc. depreciation—capital leases



( a) Assuming the lessee’s 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’s income statement for the year ending September 30, 2016?



3. $ 19,875 $ 5,500 $ 50,064



Interest expense (See amortization schedule) Lease executory expense Depreciation expense ($300,383 ÷ 6 = $50,064) 8



( a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 4) What items and amounts will appear on the lessee’s balance sheet at September 30, 2016?



4.



$ 42,825 $ 19,875



Current liabilities: Lease liability Interest payable



$155,926



Long-term liabilities: Lease liability



$300,383 ($100,128)



Property, plant, and equipment: Leased Equipment Acc. depreciation—capital leases



( b) Assuming the lessee’s 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’s income statement for the year ending December 31, 2014?



(b) 1.$ 5,942 Interest expense ($23,768 X 3/12 = $5,942) $ 1,375 Lease executory expense ($5,500 X 3/12 = $1,375) $ 12,516 Depreciation expense ($300,383 ÷ 6 = $50,064; ($50,064 X 3/12 = $12,516)



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( b) Assuming the lessee’s accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 2) What items and amounts will appear on the lessee’s balance sheet at December 31, 2014?



2. $ 38,932 $ 5,942



Current liabilities: Lease liability Interest payable



$198,751



Long-term liabilities: Lease liability



$300,383 ($12,516) $



4,125



Property, plant, and equipment: Leased equipment Acc depreciation—capital leases Current assets: Prepaid lease executory costs ($5,500 X 9/12 = $4,125)



( b) Assuming the lessee’s 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’s income statement for the year ending December 31, 2015?



3. $ 22,795 = $ 5,500 $ 50,064



Interest expense [($23,768 – $5,942) + ($19,875 X 3/12) [$17,826 + $4,969 = $22,795] Lease executory expense Depreciation expense ($300,383 ÷ 6 = $50,064)



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( b) Assuming the lessee’s accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2015?



4. $ 42,825 $ 4,969



$155,926 $300,383 ($62,580)



$



4,125



Current liabilities: Lease liability Interest payable ($19,875 X 3/12 = $4,969) Long-term liabilities: Lease liability Property, plant, and equipment: Leased equipment Acc depreciation—capital leases ($12,516 + $50,064 = $62,580)



Current assets: Prepaid lease executory costs ($5,500 X 9/12 = $4,125)



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E21- 11 (Amortization Schedule and Journal Entries for Lessee) Laura Leasing Company signs an agreement on January 1, 2014, to lease equipment to Plote Company. The following information relates to this agreement. 1. The term of the noncancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years. 2. The fair value of the asset at January 1, 2014, is $ 80,000. 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 $ 7,000, none of which is guaranteed. 4. Plote Company assumes direct responsibility for all executory costs, which include the following annual amounts: ( 1) $ 900 to Rocky Mountain Insurance Company for insurance and ( 2) $ 1,600 to Laclecde County for property taxes. 5. The agreement requires equal annual rental payments of $ 18,142.95 to the lessor, beginning on January 1, 2014. 6. The lessee’s incremental borrowing rate is 12%. The lessor’s implicit rate is 10% and is known to the lessee. 7. Plote Company uses the straight- line depreciation method for all equipment. 8. Plote uses reversing entries when appropriate. Instructions (Round all numbers to the nearest cent.) ( a) Prepare an amortization schedule that would be suitable for the lessee for the lease term. ( b) Prepare all of the journal entries for the lessee for 2014 and 2015 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31.



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EXERCISE 21-11 (20–30 minutes) Note: This lease is a capital lease to the lessee because the lease term (five years) exceeds 75% of the remaining economic life of the asset (five years). Also, the present value of the minimum lease payments exceeds 90% of the fair value of the asset. $18,142.95 Annual rental payment X 4.16986 PV of an annuity due of 1 for n = 5, i = 10% $75,653.56 PV of minimum lease payments (a)



PLOTE COMPANY (Lessee) Lease Amortization Schedule



Date 1/1/14 1/1/14 1/1/15 1/1/16 1/1/17 1/1/18



Annual Lease Interest (10%) Payment on Liability $18,142.95 18,142.95 18,142.95 18,142.95 18,142.95 $90,714.75



$



–0– 5,751.06 4,511.87 3,148.76 1,649.50* $15,061.19



*Rounding error is 15 cents.



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Reduction of Lease Liability $18,142.95 12,391.89 13,631.08 14,994.19 16,493.45 $75,653.56



Lease Liability $75,653.56 57,510.61 45,118.72 31,487.64 16,493.45 0



(b) 1/1/14 75,653.56 1/1/14 18,142.95



Leased Equipment....................... Lease Liability.......................



75,653.56



Lease Liability.............................. Cash.......................................



18,142.95



During 2014



900.00



1,600.00 12/31/14 5,751.06



15,130.71



Insurance Expense...................... Cash.......................................



900.00



Property Tax Expense.................. Cash.......................................



1,600.00



Interest Expense............................... Interest Payable........................



5,751.06



Depreciation Expense...................... Accumulated Depreciation— Capital Leases.......................



15,130.71



($75,653.56 ÷ 5 = $15,130.71)



Note: Difference in treatment of guaranteed residual value vs. unguaranteed residual value Unguaranteed residual value is not deducted from cost to arrive at depreciable cost. 14



Guaranteed residual value is deducted from cost to arrive at depreciable cost.



1/1/15 5,751.06



Interest Payable............................................ Interest Expense.......................



5,751.06



Interest Expense............................... Lease Liability................................... Cash...........................................



5,751.06 12,391.89



18,142.95



During 2015



900.00



1,600.00 12/31/15 4,511.87



15,130.71



Insurance Expense........................... Cash...........................................



900.00



Property Tax Expense...................... Cash...........................................



1,600.00



Interest Expense............................... Interest Payable........................



4,511.87



Depreciation Expense...................... Accumulated Depreciation— Capital Leases.......................



15,130.71



15



Note 1. The lessor sets the annual rental payment as follows: Fair value of leased asset to lessor Less: Present value of unguaranteed residual value $7,000 X .62092 (present value of 1 at 10% for 5 periods) Amount to be recovered through lease $75,653.56 Five periodic lease payments $75,653.56 ÷ 4.16986*



payments



*Present value of annuity due of 1 for 5 periods at 10%. 2.



The unguaranteed residual value is not subtracted when depreciating the leased asset.



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E21- 12 ( Accounting for an Operating Lease) On January 1, 2014, 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, 2014. 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. Both the lessor and the lessee are on a calendar- year basis. Instructions ( a) Prepare the journal entries that Nelson Co. should make in 2014. ( b) Prepare the journal entries that Wise Inc. should make in 2014. ( c) If Nelson paid $ 30,000 to a real estate broker on January 1, 2014, as a fee for finding the lessee, how much should be reported as an expense for this item in 2014 by NelsonCo.?



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EXERCISE 21-12 (a) Entries for Doug Nelson are as follows: 1/1/14 4,500,000 12/31/14 275,000



90,000



95,000



Buildings......................................... Cash.............................................



4,500,000



Cash................................................. Rent Revenue..........................



275,000



Depreciation Expense.................... Accumulated Depreciation— Buildings.............................



90,000



($4,500,000 ÷ 50) Property Tax Expense.................... Insurance Expense......................... Cash.........................................



18



85,000 10,000



(b) Entries for Patrick Wise are as follows: 12/31/14 275,000



Rent Expense.................................. Cash.........................................



275,000



(c) The real estate broker’s fee should be capitalized and amortized equally over the 10-year period. As a result, real estate fee expense of $3,000 ($30,000 ÷ 10) should be reported in each period.



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