The following facts pertain to a non-cancelable lease agreement between Lennox Leasing Company and Gill Company, a lessee.

Inception date: May 1, 2017

Annual lease payment due at the beginning of each year, beginning with May 1, 2017: \(18,829.49

Bargain-purchase option price at end of lease term: \)4,000.00

Lease term: 5 years

Economic life of leased equipment: 10 years

Lessor’s cost: \(65,000.00; fair value of asset at May 1, 2017, \)81,000.00

Lessor’s implicit rate: 10%; lessee’s incremental borrowing rate 10%

The lessee assumes responsibility for all executory costs.

Instructions

(Round all numbers to the nearest cent.)

(a) Discuss the nature of this lease to Gill Company.

Short Answer

Expert verified

Answer

The lease agreement has a bargain-purchase option.

Step by step solution

01

Meaning of Lease Agreement

A lease agreement is referred to as a contract in which one party transfers ownership of a real estate to another party for a certain period of time, subject to certain conditions, in exchange for something of value.

02

Discussing the nature of the lease

From the lessee's perspective, the lease agreement has a bargain-purchase option and so fits the criteria to be categorized as a finance lease. Furthermore, the present value of the minimum lease payments is practically all (more than 90%) of the asset's fair value.

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Most popular questions from this chapter

(Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for \(900,000 by Young Co. The machine is expected to have an 8-year life with no salvage value. It is to be depreciated on a straight-line basis. The machine was leased to St. Leger Inc. on January 1, 2017, at an annual rental of \)210,000. Other relevant information is as follows.

  1. The lease term is for 3 years.
  2. Young Co. incurred maintenance and other executory costs of \(25,000 in 2017 related to this lease.
  3. The machine could have been sold by Young Co. for \)940,000 instead of leasing it.
  4. St. Leger is required to pay a rent security deposit of \(35,000 and to prepay the last month’s rent of \)17,500.

Instructions

(b) What amount should St. Leger Inc. report for rent expenses for 2017 on this lease?

Use the information for IBM from BE21-6. Assume the direct-financing lease was recorded at a present value of \(150,000. Prepare IBM’s December 31, 2017, entry to record interest.

Assume that IBM leased equipment that was carried at a cost of \)150,000 to Sharon Swander Company. The term of the lease is 6 years beginning January 1, 2017, with equal rental payments of \(30,044 at the beginning of each year. All executory costs are paid by Swander directly to third parties. The fair value of the equipment at the inception of the lease is \)150,000. The equipment has a useful life of 6 years with no salvage value. The lease has an implicit interest rate of 8%, no bargain-purchase option, and no transfer of title. Collectibility is reasonably assured with no additional cost to be incurred by IBM. Prepare IBM’s January 1, 2017, journal entries at the inception of the lease.

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’s 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

(a) Explain the probable relationship of the $550,000 amount to the lease arrangement.

Use the information for Rick Kleckner Corporation from BE21-3. Assume that at December 31, 2017, Kleckner made an adjusting entry to accrue interest expense of \(29,530 on the lease. Prepare Kleckner’s January 1, 2018, journal entry to record the second lease payment of \)53,920.

Rick Kleckner Corporation recorded a capital lease at \(300,000 on January 1, 2017. The interest rate is 12%. Kleckner Corporation made the first lease payment of \)53,920 on January 1, 2017. The lease requires eight annual payments. The equipment has a useful life of 8 years with no salvage value. Prepare Kleckner Corporation’s December 31, 2017, adjusting entries.

(Operating Lease for Lessee and Lessor) On February 20, 2017, Barbara Brent Inc. purchased a machine for \(1,500,000 for the purpose of leasing it. The machine is expected to have a 10-year life, no residual value, and will be depreciated on the straight-line basis. The machine was leased to Rudy Company on March 1, 2017, for a 4-year period at a monthly rental of \)19,500. There is no provision for the renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. Brent paid $30,000 of commissions associated with negotiating the lease in February 2017.

Instructions

(b) What income or loss before income taxes should Brent record as a result of the facts above for the year ended December 31, 2017? (Hint: Amortize commissions over the life of the lease.)

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