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Chapter 21: 21-1E-a (page 1240)

Question: Lessee Entries; Capital Lease with Unguaranteed Residual Value) On January 1, 2017, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of \(8,668 at the beginning of each year, starting January 1, 2017. The machine has an estimated useful life of 6 years and a \)5,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.

Instructions

What type of lease is this? Explain

Short Answer

Expert verified

Answer

Burke Corporation has a Capital lease.

Step by step solution

01

Meaning of Lessee

When a lessor gives the right to use an asset on an agreement to a person known as a lessee. A lessee is not the owner but has the right to use the leased asset and, in return, the lessee makes payments to the lessor.

02

Explaining the type of lease

Burke has a capital lease because the term of the lease (5 years) exceeds 75% of the economic life (6 years) of the leased asset. The lease term is longer (5÷6 ) 831/3% of the economic life of the asset.

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Most popular questions from this chapter

(Lessor Entries; Sales-Type Lease) Crosley Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, 2017. The lease is for an 8-year period and requires equal annual payments of \(35,013 at the beginning of each year. The first payment is received on January 1, 2017. Crosley had purchased the machine during 2016 for \)160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by Crosley. Crosley set the annual rental to ensure an 11% rate of return. The machine has an economic life of 10 years with no residual value and reverts to Crosley at the termination of the lease.

Instructions

(b) Prepare all necessary journal entries for Crosley for 2017.

Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston’s specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is \)2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Instructions

(e) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2017. (Prepare a lease amortization schedule for 2 years.)

Outline the accounting procedures involved in applying the operating method by a lessor.

(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 \(40,000 are to be made at the beginning of each lease year (December 31). The taxes, insurance, and the maintenance costs are the obligation of the lessee. The interest rate used by the lessor in setting the payment schedule is 9%; Ludwick’s incremental borrowing rate is 10%. Ludwick is unaware of the rate being used by the lessor. At the end of the lease, Ludwick has the option to buy the equipment for \)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

  1. Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2017, by Ludwick.

(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

(d) How should Evans report the lease transaction on its December 31, 2017, balance sheet?
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