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Chapter 21: Q10P_a(3) (page 1248)

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) 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

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

(3) Cost of sales.

Short Answer

Expert verified

Cost of sales is $172,289.

Step by step solution

01

Meaning of Cost of Sales

Cost of sales can be referred to as the total amount that a retailer or wholesaler incurs to purchase a particular item. On the income statement, the cost of sales is shown as a direct cost.

02

Explaining the nature of the lease in relation to the lessor

The lease is a sales-type lease because:

1) The lease period exceeds 75% of the asset's expected economic life (10/12 = 83%),

2) Payment collectability is fairly ensured, and no further expenditures are paid, and

3) George Company made a profit in addition to the financing fee.

03

Computation of cost of sales

The cost of sales is $172,289 (the asset's $180,000 cost is less than the present value of the $7,711 unguaranteed residual value).

Costofsales=Assetsvale-Unguaranteedresidualvalue=$180,000-$7,711=$172,289

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Most popular questions from this chapter

(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.

On January 1, 2017, Irwin Animation sold a truck to Peete Finance for \(33,000 and immediately leased it back. The truck was carried on Irwin’s books at \)28,000. The term of the lease is 5 years, and title transfers to Irwin at lease-end. The lease requires five equal rental payments of $8,705 at the end of each year. The appropriate rate of interest is 10%, and the truck has a useful life of 5 years with no salvage value. Prepare Irwin’s 2017 journal entries.

(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

(a) How much should Young Co. report as income before income tax on this lease 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

(f) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2017, for both the lessee and the lessor.

(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

(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.
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