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Chapter 21: Q21-8E-c (page 1242)

Question: (Lessee Entries with Bargain-Purchase Option) The following facts pertain to a noncancelable lease agreement between Mooney Leasing Company and Rode Company, a lessee.

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%

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs.

Instructions

(Round all numbers to the nearest cent.)

(c) Prepare a lease amortization schedule for Rode Company for the 5-year lease term.

Short Answer

Expert verified

Answer

The lease liability is $91,000.

Step by step solution

01

Meaning of lease asset Amortization

The amortization of a leased asset is determined by the asset's historical cost, expected economic life, residual value, and the amortization method. Most finance leases are amortized with continuous payments over the term of the lease and are customized to meet the specific needs of the lessee.

02

Preparing a lease amortization for Rode Company for the 5-year lease term.

Computation of lease liability

Annual rental payment

$21,227.65

PV of annuity due of 1 for n = 5,i= 10%

4.16986

PV of periodic rental payments

$88,516.32

Bargain purchase option

$ 4,000.00

PV of 1 for n = 5,i= 10%

.62092

PV of bargain-purchase option

$ 2,483.68

PV of periodic rental payments

$88,516.32

PV of bargain-purchase option

+ 2,483.68

Lease liability

$91,000.00


RODE COMPANY (Lessee)

Lease Amortization Schedule

Date

Annual Lease Payment

Plus BPO

Interest (10%) in Liability

Reduction of Lease Liability

Lease Liability

5/1/17

$91,000.00

5/1/17

$ 21,227.65

$21,227.65

69,772.35

5/1/18

21,227.65

$6,977.24

14,250.41

55,521.94

5/1/19

21,227.65

5,552.19

15,675.46

29,846.48

5/1/20

21,227.65

3984.65

17,243.00

22,603.48

5/1/21

21,227.65

2,260.35

18,967.30

3,636.18

4/30/22

4,000.00

363.82

3,636.18

0

$110,138.25

$19,138.25

$91,000.00

Note: Rounding error is 20 cents

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Most popular questions from this chapter

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.)

(b) Prepare an amortization schedule that would be suitable for the lessor for the lease term.

(Lessor Entries; Sales-Type Lease) Crosley Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, 2017. The lease is for an 8-year period and requires equal annual payments of \(35,013 at the beginning of each year. The first payment is received on January 1, 2017. Crosley had purchased the machine during 2016 for \)160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by Crosley. Crosley set the annual rental to ensure an 11% rate of return. The machine has an economic life of 10 years with no residual value and reverts to Crosley at the termination of the lease.

Instructions

(b) Prepare all necessary journal entries for Crosley for 2017.

(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

(c) Prepare all of the lessee’s journal entries for the first year. Assume straight-line depreciation.

(Operating Lease vs. Capital Lease) You are auditing the December 31, 2017, financial statements of Hockney, Inc., manufacturer of novelties and party favors. During your inspection of the company garage, you discovered that a used automobile not listed in the equipment subsidiary ledger is parked there. You ask Stacy Reeder, plant manager, about the vehicle, and she tells you that the company did not list the automobile because the company was only leasing it. The lease agreement was entered into on January 1, 2017, with Crown New and Used Cars.

You decide to review the lease agreement to ensure that the lease should be afforded operating lease treatment, and you discover the following lease terms.

  1. Noncancelable term of 4 years.
  2. 2. Rental of \(3,240 per year (at the end of each year). (The present value at 8% per year is \)10,731.)
  3. 3. Estimated residual value after 4 years is \(1,100. (The present value at 8% per year is \)809.) Hockney guarantees the residual value of $1,100.
  4. 4. Estimated economic life of the automobile is 5 years.
  5. 5. Hockney’s incremental borrowing rate is 8% per year.

Instructions

You are a senior auditor writing a memo to your supervisor, the audit partner in charge of this audit, to discuss the above situation. Be sure to include (a) why you inspected the lease agreement, (b) what you determined about the lease, and (c) how you advised your client to account for this lease. Explain every journal entry that you believe is necessary to record this lease properly on the client’s books. (It is also necessary to include the fact that you communicated this information to your client.)

Jennifer Brent Corporation owns equipment that cost \(80,000 and has a useful life of 8 years with no salvage value. On January 1, 2017, Jennifer Brent leases the equipment to Donna Havaci Inc. for 1 year with one rental payment of \)15,000 on January 1. Prepare Jennifer Brent Corporation’s 2017 journal entries.
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