EXERCISES
E21-1 (L02) (Lessee Entries; Capital Lease with Unguaranteed Residual Value) On January 1, 2017, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $8,668 at the beginning of each year, starting January 1, 2017. The machine has an estimated useful life of 6 years and a $5,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.
Instructions
(a) What type of lease is this? Explain.
(b) Compute the present value of the minimum lease payments.
(c) Prepare all necessary journal entries for Burke for this lease through January 1, 2018.
E21-2 (L02) (Lessee Computations and Entries; Capital Lease with Guaranteed Residual Value) Pat Delaney Company leases an automobile with a fair value of $8,725 from John Simon Motors, Inc., on the following terms:
1. Noncancelable term of 50 months.
2. Rental of $200 per month (at end of each month). (The present value at 1% per month is $7,840.)
3. Estimated residual value after 50 months is $1,180. (The present value at 1% per month is $715.) Delaney Company guarantees the residual value of $1,180.
4. Estimated economic life of the automobile is 60 months.
5. Delaney Company’s incremental borrowing rate is 12% a year (1% a month). Simon’s implicit rate is unknown.
Instructions
(a) What is the nature of this lease to Delaney Company?
(b) What is the present value of the minimum lease payments?
(c) Record the lease on Delaney Company’s books at the date of inception.
(d) Record the first month’s depreciation on Delaney Company’s books (assume straight-line).
(e) Record the first month’s lease payment.
E21-3 (L02,4) EXCEL (Lessee Entries; Capital Lease with Executory Costs and Unguaranteed Residual Value) Assume that on January 1, 2017, Kimberly-Clark Corp. signs a 10-year noncancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement.
1. The agreement requires equal rental payments of $72,000 beginning on January 1, 2017.
2. The fair value of the building on January 1, 2017, is $440,000.
3. The building has an estimated economic life of 12 years, with an unguaranteed residual value of $10,000. Kimberly-Clark depreciates similar buildings on the straight-line method.
4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor.
5. Kimberly-Clark’s incremental borrowing rate is 12% per year. The lessor’s implicit rate is not known by Kimberly-Clark.
6. The yearly rental payment includes $2,471 of executory costs related to taxes on the property.
Instructions
Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. Kimberly-Clark’s corporate year-end is December 31.
E21-4 (L03) (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
(a) Prepare the journal entries on the books of Castle Leasing to reflect the payments received under the lease and to recognize income for the years 2017 and 2018.
(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.
E21-5 (L02,3) (Type of Lease; Amortization Schedule) Mike Macinski Leasing Company leases a new machine that has a cost and fair value of $95,000 to Sharrer Corporation on a 3-year noncancelable contract. Sharrer Corporation agrees to assume all risks of normal ownership including such costs as insurance, taxes, and maintenance. The machine has a 3-year useful life and no residual value. The lease was signed on January 1, 2017. Mike Macinski Leasing Company expects to earn a 9% return on its investment. The annual rentals are payable on each December 31.
Instructions
(a) Discuss the nature of the lease arrangement and the accounting method that each party to the lease should apply.
(b) Prepare an amortization schedule that would be suitable for both the lessor and the lessee and that covers all the years involved.
E21-6 (L04) EXCEL (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
(a) Compute the amount of the lease receivable.
(b) Prepare all necessary journal entries for Crosley for 2017.
E21-7 (L04) (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.
(b) Calculate the amount of the annual rental payment.
(c) Prepare all the necessary journal entries for Flynn for 2017.
(d) Prepare all the necessary journal entries for Bensen for 2017.
E21-8 (L04) (Lessee Entries with Bargain-Purchase Option) The following facts pertain to a noncancelable lease agreement between Mooney Leasing Company and Rode Company, a lessee.
Instructions
(Round all numbers to the nearest cent.)
(a) Discuss the nature of this lease to Rode Company.
(b) Discuss the nature of this lease to Mooney Leasing Company.
(c) Prepare a lease amortization schedule for Rode Company for the 5-year lease term.
(d) Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. Rode’s annual accounting period ends on December 31. Reversing entries are used by Rode.
E21-9 (L04) (Lessor Entries with Bargain-Purchase Option) A lease agreement between Mooney Leasing Company and Rode Company is described in E21-8.
Instructions
(Round all numbers to the nearest cent.)
Refer to the data in E21-8 and do the following for the lessor.
(a) Compute the amount of the lease receivable at the inception of the lease.
(b) Prepare a lease amortization schedule for Mooney Leasing Company for the 5-year lease term.
(c) Prepare the journal entries to reflect the signing of the lease agreement and to record the receipts and income related to this lease for the years 2017, 2018, and 2019. The lessor’s accounting period ends on December 31. Reversing entries are not used by Mooney.
E21-10 (L03) (Computation of Rental; Journal Entries for 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.)
(b) Prepare an amortization schedule that would be suitable for the lessor for the lease term.
(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.
E21-11 (L02) (Amortization Schedule and Journal Entries for Lessee) Laura Leasing Company signs an agreement on January 1, 2017, 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, 2017, 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 Laclede County for property taxes.
5. The agreement requires equal annual rental payments of $18,142.95 to the lessor, beginning on January 1, 2017.
6. The lessee’s incremental borrowing rate is 12%. The lessor’s 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 2017 and 2018 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31.
E21-12 (L02,3) (Accounting for an Operating Lease) On January 1, 2017, 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, 2017.
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 2017.
(b) Prepare the journal entries that Wise Inc. should make in 2017.
(c) If Nelson paid $30,000 to a real estate broker on January 1, 2017, as a fee for finding the lessee, how much should Nelson Co. report as an expense for this item in 2017?
E21-13 (L02,3) (Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for $900,000 by
Young Co. The machine is expected to have an 8-year life with no salvage value. It is to be depreciated on a straight-line basis.
The machine was leased to St. Leger Inc. on January 1, 2017, at an annual rental of $210,000. Other relevant information is as follows.
1. The lease term is for 3 years.
2. Young Co. incurred maintenance and other executory costs of $25,000 in 2017 related to this lease.
3. The machine could have been sold by Young Co. for $940,000 instead of leasing it.
4. St. Leger is required to pay a rent security deposit of $35,000 and to prepay the last month’s rent of $17,500.
Instructions
(a) How much should Young Co. report as income before income tax on this lease for 2017?
(b) What amount should St. Leger Inc. report for rent expense for 2017 on this lease?
E21-14 (L02,3) (Operating Lease for Lessee and Lessor) On February 20, 2017, Barbara Brent Inc. purchased a machine for $1,500,000 for the purpose of leasing it. The machine is expected to have a 10-year life, no residual value, and will be depreciated on the straight-line basis. The machine was leased to Rudy Company on March 1, 2017, for a 4-year period at a monthly rental of $19,500. There is no provision for the renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. Brent paid $30,000 of commissions associated with negotiating the lease in February 2017.
Instructions
(a) What expense should Rudy Company record as a result of the facts above for the year ended December 31, 2017? Show supporting computations in good form.
(b) What income or loss before income taxes should Brent record as a result of the facts above for the year ended December 31, 2017? (Hint: Amortize commissions over the life of the lease.)
(AICPA adapted)
*E 21-15 (L05) (Sale-Leaseback) Assume that on January 1, 2017, Elmer’s Restaurants sells a computer system to Liquidity
Finance Co. for $680,000 and immediately leases the computer system back. The relevant information is as follows.
1. The computer was carried on Elmer’s books at a value of $600,000.
2. The term of the noncancelable lease is 10 years; title will transfer to Elmer.
3. The lease agreement requires equal rental payments of $110,666.81 at the end of each year.
4. The incremental borrowing rate for Elmer is 12%. Elmer is aware that Liquidity Finance Co. set the annual rental to ensure a rate of return of 10%.
5. The computer has a fair value of $680,000 on January 1, 2017, and an estimated economic life of 10 years.
6. Elmer pays executory costs of $9,000 per year.
Instructions
Prepare the journal entries for both the lessee and the lessor for 2017 to reflect the sale and leaseback agreement. No uncertainties exist, and collectibility is reasonably certain.
*E 21-16 (L05) (Lessee-Lessor, Sale-Leaseback) 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.
(b) On December 31, 2017, Wasicsko Co. sold a machine to Cross Co. and simultaneously leased it back for one year. The sales price of the machine was $480,000, the carrying amount is $420,000, and it had an estimated remaining useful life of 14 years. The present value of the rental payments for the one year is $35,000. At December 31, 2017, how much should Wasicsko report as deferred revenue from the sale of the machine?
(c) On January 1, 2017, McKane Corp. sold an airplane with an estimated useful life of 10 years. At the same time, McKane leased back the plane for 10 years. The sales price of the airplane was $500,000, the carrying amount $379,000, and the annual rental $73,975.22. McKane Corp. intends to depreciate the leased asset using the sum-of-the-years’-digits depreciation method. Discuss how the gain on the sale should be reported at the end of 2017 in the financial statements.
(d) On January 1, 2017, Sondgeroth Co. sold equipment with an estimated useful life of 5 years. At the same time, Sondgeroth leased back the equipment for 2 years under a lease classified as an operating lease. The sales price (fair value) of the equipment was $212,700, the carrying amount is $300,000, the monthly rental under the lease is $6,000, and the present value of the rental payments is $115,753. For the year ended December 31, 2017, determine which items would be reported on its income statement for the sale-leaseback transaction.
