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Chapter 21: Q21-12P_b(3) (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

(b) Assuming that the present value of terminal facilities and related obligation at January 1, 2017, was \(7,600,000, prepare journal entries for Grishell Trucking Company to record the:

3) Accrual of interest expense at December 31, 2019.

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 interest expense is $359,549.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Interest Expense

Interest expense can be referred to as the entire interest amount that accrues from any borrowed funds such as loans or credits. Too much interest expense can cut into a company's profits.

02

Step 2:Preparing journal entry

Date

Particular

Debit ($)

Credit ($)

Interest Expense

359,549

Interest Payable

359,549

(To record interest accrual at 6% on outstanding debt of $5,992,480)

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Most popular questions from this chapter

Alice Foyle, M.D. (lessee), has a noncancelable 20-year lease with Brownback Realty, Inc. (lessor) for the use of a medical building. Taxes, insurance, and maintenance are paid by the lessee in addition to the fixed annual payments, of which the present value is equal to the fair value of the leased property. At the end of the lease period, title becomes the lessee’s at a nominal price. Considering the terms of the lease described above, comment on the nature of the lease transaction and the accounting treatment that should be accorded it by the lessee.

(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

(b) Prepare the journal entries that Wise Inc. should make in 2017

Assume that on January 1, 2017, Kimberly-Clark Corp. signs a 10-year noncancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement. 1. The agreement requires equal rental payments of \(72,000 beginning on January 1, 2017. 2. The fair value of the building on January 1, 2017, is \)440,000. 3. The building has an estimated economic life of 12 years, with an unguaranteed residual value of \(10,000. Kimberly-Clark depreciates similar buildings on the straight-line method. 4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor. 5. Kimberly-Clark’s incremental borrowing rate is 12% per year. The lessor’s implicit rate is not known by Kimberly-Clark. 6. The yearly rental payment includes \)2,471 of executory costs related to taxes on the property.

Instructions

Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. Kimberly-Clark’s corporate year-end is December 31.

(Lessee Accounting and Reporting) On January 1, 2017, Evans Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Evans by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2017, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Instructions

(c) What expenses related to this lease will Evans incur during the first year of the lease, and how will they be determined?

(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?
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