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ACC 326

Ch. 21 LeasesIn Class Discussion15th edP21-1, P21-4, E21-11 and E21-12

P21- 1 ( Lessee- Lessor Entries, Sales- Type Lease)

Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2014. 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, 2014, 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, 2014. 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. Jensens incremental borrowing rate is 11%, and the lessors implicit rate is unknown. Instructions ( Assume the accounting period ends on December 31.) ( a) Discuss the nature of this lease for both the lessee and the lessor. ( b) Calculate the amount of the annual rental payment required. ( c) Compute the present value of the minimum lease payments. ( d) Prepare the journal entries Jensen would make in 2014 and 2015 related to the lease arrangement. ( e) Prepare the journal entries Glaus would make in 2014 and 2015.

PROBLEM 21-1

(a)This is a capital lease to Jensen since the lease term is greater than 75% of the economic life of the leased asset. The lease term is 78% (79) of the assets economic life.

This is a capital lease to Glaus because collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is greater than 75% of the assets economic life. Since the fair value ($700,000) of the equipment exceeds the lessors cost ($525,000), the lease is a sales-type lease.

(b)Calculation of annual rental payment:

= $121,130

**Present value of $1 at 10% for 7 periods.**Present value of an annuity due at 10% for 7 periods.

(c)Computation of present value of minimum lease payments:PV of annual payments:$121,130 X 5.23054** =$633,575PV of guaranteed residual value:$100,000 X .48166** = 48,166$681,741**Present value of an annuity due at 11% for 7 periods.**Present value of $1 at 11% for 7 periods.

(d)1/1/14Leased Equipment681,741Lease Liability681,741

Lease Liability121,130Cash121,130

12/31/14Depreciation Expense 83,106Accumulated Depreciation Capital Leases ($681,741 $100,000) 783,106

Interest Expense 61,667Interest Payable ($681,741 $121,130) X .1161,667

1/1/15Lease Liability 59,463Interest Payable 61,667Cash121,130

12/31/15Depreciation Expense 83,106Accumulated Depreciation Capital Leases 83,106

Interest Expense 55,126Interest Payable55,126 [($681,741 $121,130 $59,463) X .11]

ACC 326: You will NOT be Tested on the Journal Entries for the Lessor

(e)1/1/14Lease Receivable700,000Cost of Goods Sold525,000Sales Revenue700,000Inventory525,000Cash121,130Lease Receivable 121,130

12/31/14Interest Receivable 57,887Interest Revenue [($700,000 $121,130) X .10]57,887

1/1/15Cash121,130Lease Receivable 63,243Interest Receivable57,887

12/31/15Interest Receivable 51,563Interest Revenue ($700,000 $121,130 $63,243) X .1051,563

P21- 4 ( Balance Sheet and Income Statement Disclosure Lessee) The following facts pertain to a non-cancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system. Inception date October 1, 2014 Lease term 6 years Economic life of leased equipment 6 years Fair value of asset at October 1, 2014 $ 300,383 Residual value at end of lease term 0 Lessors implicit rate 10% Lessees incremental borrowing rate 10% Annual lease payment due at the beginning of each year, beginning with October 1, 2014 $ 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, 2042. ( 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.

Annual Lease Interest ( 10%) Reduction Balance of Payment/ on Unpaid of Lease Lease Date Receipt Liability/ Receivable Liability/ Receivable Liability/ Receivable 10/ 01/ 14 $ 300,383 10/ 01/ 14 $ 62,700 $ 62,700 237,683 10/ 01/ 15 62,700 $ 23,768 38,932 198,751 10/ 01/ 1662,700 19,875 42,825 155,926 10/ 01/ 17 62,700 15,593 47,107 108,819 10/ 01/ 18 62,700 10,822 51,818 57,001 10/ 01/ 19 62,700 5,699* 57,001 0 $ 376,200 $ 75,817 $ 300,383 * Rounding error is $ 1.Instructions ( Round all numbers to the nearest cent.)

( a) Assuming the lessees accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessees income statement for the year ending September 30, 2015? ( 2) What items and amounts will appear on the lessees balance sheet at September 30, 2015? ( 3) What items and amounts will appear on the lessees income statement for the year ending September 30, 2016? ( 4) What items and amounts will appear on the lessees balance sheet at September 30, 2016?

( b) Assuming the lessees accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessees income statement for the year ending December 31, 2014? ( 2) What items and amounts will appear on the lessees balance sheet at December 31, 2014? ( 3) What items and amounts will appear on the lessees income statement for the year ending December 31, 2015? ( 4) What items and amounts will appear on the lessees balance sheet at December 31, 2015?

PROBLEM 21-4

( a) Assuming the lessees accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessees income statement for the year ending September 30, 2015?

(a)1.$ 23,768 Interest expense (See amortization schedule)$ 5,500 Lease executory expense$ 50,064 Depreciation expense ($300,383 6 = $50,064)

( a) Assuming the lessees accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 2) What items and amounts will appear on the lessees balance sheet at September 30, 2015?

2.Current liabilities:$ 38,932Lease liability$ 23,768Interest payable

Long-term liabilities:$198,751Lease liability

Property, plant, and equipment:$300,383Leased equipment ($50,064)Acc. depreciationcapital leases

( a) Assuming the lessees accounting period ends on September 30, answer the following questions with respect to this lease agreement.

( 3) What items and amounts will appear on the lessees income statement for the year ending September 30, 2016?

3.$ 19,875 Interest expense (See amortization schedule)$ 5,500Lease executory expense$ 50,064 Depreciation expense ($300,383 6 = $50,064)

( a) Assuming the lessees accounting period ends on September 30, answer the following questions with respect to this lease agreement. ( 4) What items and amounts will appear on the lessees balance sheet at September 30, 2016?

4.Current liabilities:$ 42,825Lease liability$ 19,875Interest payable

Long-term liabilities:$155,926Lease liability

Property, plant, and equipment:$300,383Leased Equipment($100,128)Acc. depreciationcapital leases

( b) Assuming the lessees accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 1) What items and amounts will appear on the lessees income statement for the year ending December 31, 2014?

(b)1.$ 5,942 Interest expense ($23,768 X 3/12 = $5,942)$ 1,375 Lease executory expense ($5,500 X 3/12 = $1,375)$ 12,516 Depreciation expense ($300,383 6 = $50,064; ($50,064 X 3/12 = $12,516)

( b) Assuming the lessees accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 2) What items and amounts will appear on the lessees balance sheet at December 31, 2014?

2.Current liabilities:$ 38,932Lease liability$ 5,942Interest payable

Long-term liabilities:$198,751Lease liability

Property, plant, and equipment:$300,383Leased equipment ($12,516) Acc depreciationcapital leases

Current assets:$ 4,125Prepaid lease executory costs ($5,500 X 9/12 = $4,125)

( b) Assuming the lessees accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 3) What items and amounts will appear on the lessees income statement for the year ending December 31, 2015?

3.$ 22,795Interest expense [($23,768 $5,942) + ($19,875 X 3/12) = [$17,826 + $4,969 = $22,795]$ 5,500Lease executory expense$ 50,064 Depreciation expense ($300,383 6 = $50,064)

( b) Assuming the lessees accounting period ends on December 31, answer the following questions with respect to this lease agreement. ( 4) What items and amounts will appear on the lessees balance sheet at December 31, 2015?

4.Current liabilities:$ 42,825Lease liability$ 4,969Interest payable ($19,875 X 3/12 = $4,969)

Long-term liabilities:$155,926Lease liability

Property, plant, and equipment:$300,383Leased equipment($62,580)Acc depreciationcapital leases ($12,516 + $50,064 = $62,580)

Current assets:$ 4,125Prepaid lease executory costs ($5,500 X 9/12 = $4,125)

E21- 11 (Amortization Schedule and Journal Entries for Lessee) Laura Leasing Company signs an agreement on January 1, 2014, to lease equipment to Plote Company. The following information relates to this agreement. 1. The term of the noncancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years. 2. The fair value of the asset at January 1, 2014, is $ 80,000. 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 $ 7,000, none of which is guaranteed. 4. Plote Company assumes direct responsibility for all executory costs, which include the following annual amounts: ( 1) $ 900 to Rocky Mountain Insurance Company for insurance and ( 2) $ 1,600 to Laclecde County for property taxes. 5. The agreement requires equal annual rental payments of $ 18,142.95 to the lessor, beginning on January 1, 2014. 6. The lessees incremental borrowing rate is 12%. The lessors implicit rate is 10% and is known to the lessee. 7. Plote Company uses the straight- line depreciation method for all equipment. 8. Plote uses reversing entries when appropriate. Instructions (Round all numbers to the nearest cent.) ( a) Prepare an amortization schedule that would be suitable for the lessee for the lease term. ( b) Prepare all of the journal entries for the lessee for 2014 and 2015 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessees annual accounting period ends on December 31.

EXERCISE 21-11 (2030 minutes)

Note: This lease is a capital lease to the lessee because the lease term (five years) exceeds 75% of the remaining economic life of the asset (five years). Also, the present value of the minimum lease payments exceeds 90% of the fair value of the asset.$18,142.95Annual rental paymentX4.16986PV of an annuity due of 1 for n = 5, i = 10%$75,653.56PV of minimum lease payments

(a)PLOTE COMPANY (Lessee)Lease Amortization Schedule

DateAnnual Lease PaymentInterest (10%) on LiabilityReduction of Lease LiabilityLease Liability

1/1/14$75,653.56

1/1/14$18,142.95$ 0$18,142.9557,510.61

1/1/1518,142.95 5,751.0612,391.8945,118.72

1/1/1618,142.954,511.8713,631.0831,487.64

1/1/1718,142.953,148.7614,994.1916,493.45

1/1/18 18,142.95 1,649.50* 16,493.450

$90,714.75$15,061.19$75,653.56

*Rounding error is 15 cents.

(b)1/1/14Leased Equipment75,653.56Lease Liability75,653.56

1/1/14Lease Liability18,142.95Cash18,142.95

During 2014

Insurance Expense 900.00Cash 900.00

Property Tax Expense 1,600.00Cash 1,600.00

12/31/14Interest Expense 5,751.06Interest Payable 5,751.06

Depreciation Expense15,130.71Accumulated Depreciation Capital Leases15,130.71 ($75,653.56 5 = $15,130.71)

Note: Difference in treatment of guaranteed residual value vs. unguaranteed residual value

Unguaranteed residual value is not deducted from cost to arrive at depreciable cost.

Guaranteed residual value is deducted from cost to arrive at depreciable cost.

1/1/15Interest Payable 5,751.06Interest Expense 5,751.06

Interest Expense 5,751.06Lease Liability12,391.89Cash18,142.95

During 2015

Insurance Expense 900.00Cash 900.00

Property Tax Expense 1,600.00Cash 1,600.00

12/31/15Interest Expense 4,511.87Interest Payable 4,511.87

Depreciation Expense15,130.71Accumulated Depreciation Capital Leases15,130.71

Note

1.The lessor sets the annual rental payment as follows:

Fair value of leased asset to lessor$80,000.00Less: Present value of unguaranteed residual value $7,000 X .62092 (present value of 1 at 10% for 5 periods) 4,346.44Amount to be recovered through lease payments$75,653.56Five periodic lease payments$75,653.56 4.16986*$18,142.95

*Present value of annuity due of 1 for 5 periods at 10%.

2.The unguaranteed residual value is not subtracted when depreciating the leased asset.

E21- 12 ( Accounting for an Operating Lease) On January 1, 2014, 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, 2014. 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. Both the lessor and the lessee are on a calendar- year basis.Instructions ( a) Prepare the journal entries that Nelson Co. should make in 2014. ( b) Prepare the journal entries that Wise Inc. should make in 2014. ( c) If Nelson paid $ 30,000 to a real estate broker on January 1, 2014, as a fee for finding the lessee, how much should be reported as an expense for this item in 2014 by NelsonCo.?

EXERCISE 21-12

(a)Entries for Doug Nelson are as follows:

1/1/14Buildings4,500,000 Cash4,500,000

12/31/14Cash 275,000Rent Revenue 275,000

Depreciation Expense 90,000Accumulated Depreciation Buildings 90,000 ($4,500,000 50)

Property Tax Expense 85,000Insurance Expense 10,000Cash 95,000

(b)Entries for Patrick Wise are as follows:

12/31/14Rent Expense 275,000Cash 275,000

(c)The real estate brokers fee should be capitalized and amortized equally over the 10-year period. As a result, real estate fee expense of $3,000 ($30,000 10) should be reported in each period.

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