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Chapter 21: 5CA (page 1252)

(Lessee Capitalization of Bargain-Purchase Option) Albertsen Corporation is considering proposals for either leasing or purchasing aircraft. The proposed lease agreement involves a twin-engine turboprop Viking that has a fair value of \(1,000,000. This plane would be leased for a period of 10 years beginning January 1, 2017. The lease agreement is cancelable only upon accidental destruction of the plane. An annual lease payment of \)141,780 is due on January 1 of each year; the first payment is to be made on January 1, 2017. Maintenance operations are strictly scheduled by the lessor, and Albertsen Corporation will pay for these services as they are performed. Estimated annual maintenance costs are \(6,900. The lessor will pay all insurance premiums and local property taxes, which amount to a combined total of \)4,000 annually and are included in the annual lease payment of \(141,780. Upon expiration of the 10-year lease, Albertsen Corporation can purchase the Viking for \)44,440. The estimated useful life of the plane is 15 years, and its salvage value in the used plane market is estimated to be \(100,000 after 10 years. The salvage value probably will never be less than \)75,000 if the engines are overhauled and maintained as prescribed by the manufacturer. If the purchase option is not exercised, possession of the plane will revert to the lessor, and there is no provision for renewing the lease agreement beyond its termination on December 31, 2026.

Albertsen Corporation can borrow \(1,000,000 under a 10-year term loan agreement at an annual interest rate of 12%. The lessor’s implicit interest rate is not expressly stated in the lease agreement, but this rate appears to be approximately 8% based on 10 net rental payments of \)137,780 per year and the initial fair value of \(1,000,000 for the plane. On January 1, 2017, the present value of all net rental payments and the purchase option of \)44,440 is \(888,890 using the 12% interest rate. The present value of all net rental payments and the \)44,440 purchase option on January 1, 2017, is $1,022,226 using the 8% interest rate implicit in the lease agreement. The financial vice president of Albertsen Corporation has established that this lease agreement is a capital lease as defined in GAAP.

Instructions

  1. What is the appropriate amount that Albertsen Corporation should recognize for the leased aircraft on its balance sheet after the lease is signed?

Short Answer

Expert verified

The appropriate amount for the leased aircraft is $1,000,000.

Step by step solution

01

Meaning of Bargain purchase option (BPO)

A BPO is alessee's contractual right to acquire a leased asset at a fixed price that is much lower than its projected fair value when the option becomes exercisable at the end of the basic lease period, with the option priced to assure execution.

02

Explaining the appropriate amount that Albertsen Corporation should recognize for the leased aircraft on its balance sheet after the lease is signed.

The proper amount of the leased aircraft should be recorded as $1,000,000 on the balance sheet of Albertson Corporation. In this case, the present value of net rental payments plus the purchase option ($1,022,226) is less than the fair value. The thing is appraised at its fair market value when this happens..

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Most popular questions from this chapter

(Lessee Computations and Entries, Capital Lease with Unguaranteed Residual Value) Assume the same data as in P21-10 with National Airlines having an incremental borrowing rate of 10%.

George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(c) Prepare all of the lessee’s journal entries for the first year. Assume straight-line depreciation.

(Lessee Computations and Entries, Capital Lease with Guaranteed Residual Value) Assume the same data as in P21-13 and that Chambers Medical Center has an incremental borrowing rate of 10%.

Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is \(411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be \)15,000. The hospital will pay rents of \(60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of \)250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.

Instructions

b) Prepare a 10-year lease amortization schedule.

(Lessee Computations and Entries, Capital Lease with Guaranteed Residual Value) Assume the same data as in P21-13 and that Chambers Medical Center has an incremental borrowing rate of 10%.

Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is \(411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be \)15,000. The hospital will pay rents of \(60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of \)250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.

Instructions

(c) Prepare all of the lessee’s journal entries for the first year.

(Accounting for an Operating Lease) On January 1, 2017, 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 \(4,500,000 and was purchased for cash on January 1, 2017.
  3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
  4. Lease payments are \)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. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

  1. Prepare the journal entries that Nelson Co. should make in 2017.

Question: (Balance Sheet and Income Statement Disclosure—Lessee) 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

–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, 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’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, 2017?
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