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Chapter 21: Q21-7E-a (page 1242)

Question: (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.

  1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
  2. Equal rental payments are due on January 1 of each year, beginning in 2017.
  3. The fair value of the equipment on January 1, 2017, is \(150,000, and its cost is \)120,000.
  4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Flynn depreciates all of its equipment on a straight-line basis.
  5. Bensen set the annual rental to ensure an 11% rate of return. Flynn’s incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
  6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.

Instructions

(Both the lessor and the lessee’s accounting period ends on December 31.)

a. Discuss the nature of this lease to Bensen and Flynn.

Short Answer

Expert verified

Answer

There is a Capital Lease to Bensen and Flynn.

Step by step solution

01

Meaning of Lease

A lease is alegally binding contract between a lessor and a lessee. The lessee has been given the right to use certain property owned by the lessee for the period specified under this agreement. The lessee pays the lessee rent payments over the term of the lease in exchange for the use of the asset.

02

Discussing the nature of the lease to Bensen and Flynn

Since the term of the lease is 75 percent ( 6/8) of the economic life of the asset, it is a capital lease for Flynn. In addition, the present value of the minimum lease payment exceeds 90% of the fair value of the asset.

Since lease payments are generally approximate, there is no significant uncertainty surrounding the lessee's future expenses, and the lease term is 75 percent of the economic life of the asset, this is a capital lease for Benson. The lease is a sale-type lease because the fair value of the equipment ($150,000) exceeds the lessor's cost ($120,000).

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Most popular questions from this chapter

Metheny Corporation’s lease arrangements qualify as sales-type leases at the time of entering into the transactions. How should the corporation recognize revenues and costs in these situations?

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) 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

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

(2) Sales price.

(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.

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

  1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
  2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
  3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
  4. Cole Company assumes direct responsibility for all executory costs.
  5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
  6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(c) Prepare all of the journal entries for the lessor for 2017 and 2018 to record the lease agreement, the receipt of lease payments, and the recognition of income. Assume the lessor’s annual accounting period ends on December 31.

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.
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