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Chapter 21: 2CA_b(2) (page 1251)

Question: (Lessor and Lessee Accounting and Disclosure) Sylvan Inc. entered into a noncancelable lease arrangement with Breton Leasing Corporation for a certain machine. Breton’s primary business is leasing; it is not a manufacturer or dealer. Sylvan will lease the machine for a period of 3 years, which is 50% of the machine’s economic life. Breton will take possession of the machine at the end of the initial 3-year lease and lease it to another, smaller company that does not need the most current version of the machine. Sylvan does not guarantee any residual value for the machine and will not purchase the machine at the end of the lease term.

Sylvan’s incremental borrowing rate is 10%, and the implicit rate in the lease is 9%. Sylvan has no way of knowing the implicit rate used by Breton. Using either rate, the present value of the minimum lease payments is between 90% and 100% of the fair value of the machine at the date of the lease agreement.

Sylvan has agreed to pay all executory costs directly, and no allowance for these costs is included in the lease payments. Breton is reasonably certain that Sylvan will pay all lease payments. Because Sylvan has agreed to pay all executory costs, there are no important uncertainties regarding costs to be incurred by Breton. Assume that no indirect costs are involved.

Instructions

(b) With respect to Breton (the lessor), answer the following.

(2) How should this lease be recorded by Breton, and how are the appropriate amounts determined?

Short Answer

Expert verified

Answer

Breton should record a Lease Receivable for the present value of the minimum lease payments and the present value of the residual value.

Step by step solution

01

Meaning of Lease Receivable

The present value of the minimum lease paymentsplus thepresent value of the unguaranteed residual value of a direct-financing lease can be described as the lease receivable. In direct-financing leases, the lessor must replace the leased asset with a lease receivable.

02

Explaining the recording of the lease by Breton  

Breton should record rent as an instant financing lease, and in order to be designated as such, all of the related requirements must be met.

  1. The rent must adhere to all of the established models for residents.
  2. A sensible selection of the smallest rent instalments.
  3. Lessor's exhibition must be nearly complete.
  4. The fair value of the rented resource must be equal to the lessor's book value.

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Most popular questions from this chapter

Use the information for Indiana Jones Corporation from BE21-9. Assume that for Lost Ark Company, the lessor, collectibility is reasonably predictable, there are no important uncertainties concerning costs, and the carrying amount of the equipment is \(202,921. Prepare Lost Ark’s January 1, 2017, journal entries.

Indiana Jones Corporation enters into a 6-year lease of equipment on January 1, 2017, which requires 6 annual payments of \)40,000 each, beginning January 1, 2017. In addition, Indiana Jones guarantees the lessor a residual value of $20,000 at lease-end. The equipment has a useful life of 6 years. Prepare Indiana Jones’ January 1, 2017, journal entries assuming an interest rate of 10%.

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.

Question: The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee.

Inception date

January 1, 2017

Annual lease payment due at the beginning of each year, beginning with January 1, 2017

\(124,798

Residual value of equipment at end of lease term, guaranteed by the lessee

\)50,000

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at January 1, 2017

\(600,000

Lessor’s implicit rate

12%

Lessee’s incremental borrowing rate

12%

The lessee assumes responsibility for all executory costs, which are expected to amount to \)5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straightline depreciation method for all equipment.

Instructions

(a) Prepare an amortization schedule that would be suitable for the lessee for the lease term.

Question: The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee.

Inception date

January 1, 2017

Annual lease payment due at the beginning of each year, beginning with January 1, 2017

\(124,798

Residual value of equipment at end of lease term, guaranteed by the lessee

\)50,000

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at January 1, 2017

\(600,000

Lessor’s implicit rate

12%

Lessee’s incremental borrowing rate

12%

The lessee assumes responsibility for all executory costs, which are expected to amount to \)5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straightline depreciation method for all equipment.

Instructions

(b) Prepare all of the journal entries for the lessee for 2017 and 2018 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 and reversing entries are used when appropriate.

The following are four independent situations.

(d) On January 1, 2017, Sondgeroth Co. sold equipment with an estimated useful life of 5 years. At the same time, Sondgeroth leased back the equipment for 2 years under a lease classified as an operating lease. The sales price (fair value) of the equipment was \(212,700, the carrying amount is \)300,000, the monthly rental under the lease is \(6,000, and the present value of the rental payments is \)115,753. For the year ended December 31, 2017, determine which items would be reported on its income statement for the sale-leaseback transaction.
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