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Chapter 21: Q21-4CA-2c (page 1252)

Question: (Comparison of Different Types of Accounting by Lessee and Lessor)

Part 2: Sales-type leases and direct-financing leases are two of the classifications of leases described in FASB pronouncements from the standpoint of the lessor.

Instructions

Compare and contrast a sales-type lease with a direct-financing lease as follows.

(c) Manufacturer’s or dealer’s profit.

Do not discuss the criteria for distinguishing between the leases described above and operating leases.

Short Answer

Expert verified

Answer

In a direct-financing lease, there is no manufacturer’s or dealer’s profit.

Step by step solution

01

Meaning of Sale-type lease

In a sales-type lease, the lessor is assumed to be selling a product to the lessee, which necessitates the reporting of a profit or loss on the sale. As a result, at the lease's start date, the following accounting is applied: (a) Recognize assets, (b) Recognize net investment.

02

Comparing and contrasting a sales-type lease with manufacturers or dealer profit.

The difference between the sales price and the carrying amount of the leased equipment is called manufacturer's or dealer's profit in a sales-type lease, and it is included in revenue in the period when the lease transaction is recorded.

There is no profit for the manufacturer or dealer in a direct-financing lease. The leasing transaction's income is entirely made up of interest.

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Most popular questions from this chapter

(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

  1. Prepare the journal entries that Nelson Co. should make in 2017.

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.

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.

The following are four independent situations.

(a) On December 31, 2017, Zarle Inc. sold computer equipment to Daniell Co. and immediately leased it back for 10 years. The sales price of the equipment was \(520,000, its carrying amount is \)400,000, and its estimated remaining economic life is 12 years. Determine the amount of deferred revenue to be reported from the sale of the computer equipment on December 31, 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.
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