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Chapter 21: Question: (page 1245)

Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

  1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
  2. The cost of the machinery is \(525,000, and the fair value of the asset on January 1, 2017, is \)700,000.
  3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight-line basis.
  4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
  5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

  1. Discuss the nature of this lease for both the lessee and the lessor.

Short Answer

Expert verified

Answer

Both Jensen Corporation and Glaus Leasing Company have the capital lease.

Step by step solution

01

Meaning of Sales-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

Explaining the nature of the lease for both lessee and the lessor

Jensen has a capital lease since the lease period exceeds 75% of the economic life of the leased asset. The lease period is 78 percent of the economic life of the asset.

This is a capital lease to Glaus because the lease payments are generally predictable, there are no significant uncertainties regarding the lessor's future expenses, and the lease period exceeds 75 percent of the asset's economic life. The lease is a sales-type lease since the market value of the equipment ($700,000) exceeds the lessor's cost ($525,000).

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Most popular questions from this chapter

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.

Assume that IBM leased equipment that was carried at a cost of \(150,000 to Sharon Swander Company. The term of the lease is 6 years beginning January 1, 2017, with equal rental payments of \)30,044 at the beginning of each year. All executory costs are paid by Swander directly to third parties. The fair value of the equipment at the inception of the lease is $150,000. The equipment has a useful life of 6 years with no salvage value. The lease has an implicit interest rate of 8%, no bargain-purchase option, and no transfer of title. Collectibility is reasonably assured with no additional cost to be incurred by IBM. Prepare IBM’s January 1, 2017, journal entries at the inception of the lease.

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.

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

(a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.

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.)

(a) Assuming the lessor desires a 10% rate of return on its investment, calculate the amount of the annual rental payment required. (Round to the nearest dollar.)
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