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Chapter 21: Q21-12P_a (page 1249)

Question: (Basic Lessee Accounting with Difficult PV Calculation) In 2016, Grishell Trucking Company negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were erected to the company’s specifications on land owned by the company. On January 1, 2017, Grishell Trucking Company took possession of the lease properties. On January 1, 2017 and 2018, the company made cash payments of \(948,000 that were recorded as rental expenses.

Although the terminals have a composite useful life of 40 years, the noncancelable lease runs for 20 years from January 1, 2017, with a bargain-purchase option available upon expiration of the lease.

The 20-year lease is effective for the period January 1, 2017, through December 31, 2036. Advance rental payments of \)800,000 are payable to the lessor on January 1 of each of the first 10 years of the lease term. Advance rental payments of \(320,000 are due on January 1 for each of the last 10 years of the lease. The company has an option to purchase all of these leased facilities for \)1 on December 31, 2036. It also must make annual payments to the lessor of \(125,000 for property taxes and \)23,000 for insurance. The lease was negotiated to assure the lessor a 6% rate of return.

Instructions

(a) Prepare a schedule to compute for Grishell Trucking Company the present value of the terminal facilities and related obligation at January 1, 2017.

Selected present value factors are as follows.

Periods

For an Ordinary Annuity of \(1 at 6%

For \)1 at 6%

1

.943396

.943396

2

1.83393

.889996

8

6.209794

.627412

9

6.801692

.591898

10

7.360087

.558395

19

11.158117

.330513

20

11.469921

.311805

Short Answer

Expert verified

Answer

The discounted present value of terminal facilities and related obligations is $7,635,410.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Present Value

Present value is a useful tool for investors since it allows them to compare values across time. PV can assist investors in determining the financial advantages of existing assets or obligations in the future. Investors can compute a present value based on future returns in areas like financial modeling, stock valuation, and bond pricing.

02

Preparing a schedule to compute for Grishell Trucking Company the present value of the terminal facilities and related obligationson January 1, 2017

GRISHELL TRUCKING COMPANY

Schedule to Compute the Discounted Present Value

of Terminal Facilities and the Related Obligation

January 1, 2017


Present value of first 10 payments:

Immediate payment $ 800,000

Present value of an ordinary annuity for

9 years at6%($800000×6.801692)5,441,354

$6,241,354

Present value of last 10 payments:

The first payment of $320,000 320,000

Present value of an ordinary annuity for

9 years at 6%$320,000×6.8016922,176,541

Present value of last 10 payments at

January 1, 20252,496,541

Discount to January 1, 2017

$2,496,541×.558395

1,394,056

Discounted present value of terminal

facilities and related obligation

$7,635,410

Note: The amount of $6,241,354 can be computed by using the present value of an annuity due for 10 periods at 6%

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Most popular questions from this chapter

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

(a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.

Rick Kleckner Corporation recorded a capital lease at \(300,000 on January 1, 2017. The interest rate is 12%. Kleckner Corporation made the first lease payment of \)53,920 on January 1, 2017. The lease requires eight annual payments. The equipment has a useful life of 8 years with no salvage value. Prepare Kleckner Corporation’s December 31, 2017, adjusting entries.

Geiberger Corporation manufactures replicators. On January 1, 2017, it leased to Althaus Company a replicator that had cost \(110,000 to manufacture. The lease agreement covers the 5-year useful life of the replicator and requires 5 equal annual rentals of \)40,800 payable each January 1, beginning January 1, 2017. An interest rate of 12% is implicit in the lease agreement. Collectibility of the rentals is reasonably assured, and there are no important uncertainties concerning costs. Prepare Geiberger’s January 1, 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?

(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

(b) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2018, by Ludwick. (Prepare the lease amortization schedule for all five payments.)
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