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Chapter 21: Q10Q (page 1239)
Outline the accounting procedures involved in applying the direct-financing method.
A lessor registers a "lease receivable" for a leased asset if the lease transaction meets the essential conditions to be categorized as a direct financing lease.
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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.
(4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2018?
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
(d) Prepare the journal entry to record the interest expense for the year 2017.
(Type of Lease; Amortization Schedule) Mike Macinski Leasing Company leases a new machine that has a cost and fair value of $95,000 to Sharrer Corporation on a 3-year noncancelable contract. Sharrer Corporation agrees to assume all risks of normal ownership including such costs as insurance, taxes, and maintenance. The machine has a 3-year useful life and no residual value. The lease was signed on January 1, 2017. Mike Macinski Leasing Company expects to earn a 9% return on its investment. The annual rentals are payable on each December 31.
Instructions
(b) Prepare an amortization schedule that would be suitable for both the lessor and the lessee and that covers all the years involved.
(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
(c) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2019, by Ludwick.
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.
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