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Chapter 21: Q16P_a. (page 1250)

(Lessee-Lessor Accounting for Residual Values) Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.

  1. The lease term is 10 years, noncancelable, and requires equal rental payments of \(30,300 due at the beginning of each year starting January 1, 2017.
  2. The equipment has a fair value and cost at the inception of the lease (January 1, 2017) of \)220,404, an estimated economic life of 10 years, and a residual value (which is guaranteed by Goring Dairy) of $20,000.
  3. The lease contains no renewable options, and the equipment reverts to King Finance Company upon termination of the lease.
  4. Goring Dairy’s incremental borrowing rate is 9% per year. The implicit rate is also 9%.
  5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.
  6. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(a) Evaluate the criteria for classification of the lease, and describe the nature of the lease. In general, discuss how the lessee and lessor should account for the lease transaction.

Short Answer

Expert verified

For the lessor, it is a direct financing lease.

For the lessee, it is a capital lease

Step by step solution

01

Meaning of lease

A lease is a bilateral agreement entered into by two persons, one who has possession of the property and the other who has the right to use the leased property for a specific period and amount.

02

Evaluating the criteria for the classification of the lease and describing the nature of the lease.

The lease agreement meets the requirements for 75 percent useful life and 90 percent fair value, collectability is generally predictable, and there are no significant uncertainties regarding the lessor's future expenses. It is a capital lease for the lessee and a direct-financing lease for the lessor (since cost equals fair value).

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Most popular questions from this chapter

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 lessor and compute the amount of each of the following items.

(3) Cost of sales.

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%.

(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

(b) Prepare a 10-year lease amortization schedule.

A lease agreement between Mooney Leasing Company and Rode Company is described in E21-8.

Inception date

May 1, 2017

Annual lease payment due at the beginning

of each year, beginning with May 1, 2017

\(21,227.65

Bargain-purchase option price at end of lease term

\) 4,000.00

Lease term

5 years

Economic life of leased equipment

10 years

Lessor’s cost

\(65,000.00

Fair value of asset at May 1, 2017

\)91,000.00

Lessor’s implicit rate

10%

Lessee’s incremental borrowing rate

10%

Instructions

(Round all numbers to the nearest cent.) Refer to the data in E21-8 and do the following for the lessor.

(c) Prepare the journal entries to reflect the signing of the lease agreement and to record the receipts and income related to this lease for the years 2017, 2018, and 2019. The lessor’s accounting period ends on December 31. Reversing entries are not used by Mooney.

(Lessor Entries; Direct-Financing Lease with Option to Purchase) Castle Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Jan Way Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement:

  1. Jan Way Company has the option to purchase the equipment for \(16,000 upon termination of the lease.
  2. The equipment has a cost and fair value of \)160,000 to Castle Leasing Company. The useful economic life is 2 years, with a salvage value of \(16,000.
  3. Jan Way Company is required to pay \)5,000 each year to the lessor for executory costs.
  4. Castle Leasing Company desires to earn a return of 10% on its investment.
  5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(b) Assuming that Jan Way Company exercises its option to purchase the equipment on December 31, 2018, prepare the journal entry to reflect the sale on Castle’s books.
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