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Chapter 21: Q7Q (page 1239)
Outline the accounting procedures involved in applying the operating method by a lessee.
A lessee's rent expense accrues day by day while the property is utilized under the operational method.
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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.
Question: (Lessee Entries and Balance Sheet Presentation, Capital Lease) On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of \(137,899 (including the executory costs of \)6,000) at the beginning of each year, starting January 1, 2017. The taxes, the insurance, and the maintenance, estimated at \(6,000 a year, are the obligations of the lessee. The leased equipment is to be capitalized at \)550,000. The asset is to be depreciated on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 12%, and the implicit rate in the lease is 10%, which is known by Cage. Title to the equipment transfers to Cage when the lease expires. The asset has an estimated useful life of 5 years and no residual value.
Instructions
(e) Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made.
Question: (Balance Sheet and Income Statement Disclosure—Lessee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.
Inception date | October 1, 2017 |
Lease term | 6 years |
Economic life of leased equipment | 6 years |
Fair value of asset at October 1, 2017 | \(300,383 |
Residual value at end of lease term | –0– |
Lessor’s implicit rate | 10% |
Lessee’s incremental borrowing rate | 10% |
Annual lease payment due at the beginning of each year, beginning with October 1, 2017 | \)62,700 |
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, which amount to \(5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This \)5,500 is not included in the rental payment of \(62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.
The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.
Date | Annual lease payments/Receipt | Interest (10%) On Unpaid liability/Receivable | Reduction of Lease Liability? Receivable | Balance of Lease Liability/Receivable |
10/01/17 | \)300,383 | |||
10/01/17 | \(62,700 | \)62,700 | 237,683 | |
10/01/18 | \(62,700 | \)23,768 | 38,932 | 198,751 |
10/01/19 | \(62,700 | 19,875 | 42,825 | 155,926 |
10/01/20 | \)62,700 | 15,593 | 47,107 | 108,819 |
10/01/21 | \(62,700 | 10,882 | 51,818 | 57,001 |
10/01/22 | \)62,700 | 5,699* | 57,001 | 0 |
\(376,200 | \)75,817 | \(300,383 |
*Rounding error is \)1.
Instructions
(a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement.
(b) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2018?
Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.
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.
(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.
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.)
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