21 Accounting for Leases PROBLEMS 21
PROBLEMS
P21-1 (L02,4) (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.)
(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 2017 and 2018 related to the lease arrangement.
(e) Prepare the journal entries Glaus would make in 2017 and 2018.
P21-2 (L02,3) GROUPWORK (Lessee-Lessor Entries, Operating Lease) Cleveland Inc. leased a new crane to Abriendo Construction under a 5-year noncancelable contract starting January 1, 2017. Terms of the lease require payments of $33,000 each January 1, starting January 1, 2017. Cleveland will pay insurance, taxes, and maintenance charges on the crane, which has an estimated life of 12 years, a fair value of $240,000, and a cost to Cleveland of $240,000. The estimated fair value of the crane is expected to be $45,000 at the end of the lease term. No bargain-purchase or -renewal options are included in the contract. Both Cleveland and Abriendo adjust and close books annually at December 31. Collectibility of the lease payments is reasonably certain, and no uncertainties exist relative to unreimbursable lessor costs. Abriendo’s incremental borrowing rate is 10%, and Cleveland’s implicit interest rate of 9% is known to Abriendo.
Instructions
(a) Identify the type of lease involved and give reasons for your classification. Discuss the accounting treatment that should be applied by both the lessee and the lessor.
(b) Prepare all the entries related to the lease contract and leased asset for the year 2017 for the lessee and lessor, assuming the following amounts.
(1) Insurance $500.
(2) Property taxes $2,000.
(3) Maintenance and repairs $650.
(4) Straight-line depreciation and salvage value $15,000.
(c) Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2017.
P21-3 (L02,4) (Lessee-Lessor Entries, Balance Sheet Presentation, Sales-Type Lease) 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.
(b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Winston Industries.
(c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Ewing Inc.
(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.
(e) Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2017. (Prepare a lease amortization schedule for 2 years.)
(f) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2017, for both the lessee and the lessor.
P21-4 (L02,4) EXCEL (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…
Instructions
(a) Assuming the lessee’s 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 lessee’s income statement for the year ending September 30, 2018?
(2) What items and amounts will appear on the lessee’s balance sheet at September 30, 2018?
(3) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2019?
(4) What items and amounts will appear on the lessee’s balance sheet at September 30, 2019?
(b) Assuming the lessee’s 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 lessee’s income statement for the year ending December 31, 2017?
(2) What items and amounts will appear on the lessee’s balance sheet at December 31, 2017?
(3) What items and amounts will appear on the lessee’s income statement for the year ending December 31, 2018?
(4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2018?
P21-5 (L03,4) EXCEL (Balance Sheet and Income Statement Disclosure—Lessor) Assume the same information as in P21-4.
Instructions
(a) Assuming the lessor’s 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 lessor’s income statement for the year ending September 30, 2018?
(2) What items and amounts will appear on the lessor’s balance sheet at September 30, 2018?
(3) What items and amounts will appear on the lessor’s income statement for the year ending September 30, 2019?
(4) What items and amounts will appear on the lessor’s balance sheet at September 30, 2019?
(b) Assuming the lessor’s 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 lessor’s income statement for the year ending December 31, 2017?
(2) What items and amounts will appear on the lessor’s balance sheet at December 31, 2017?
(3) What items and amounts will appear on the lessor’s income statement for the year ending December 31, 2018?
(4) What items and amounts will appear on the lessor’s balance sheet at December 31, 2018?
P21-6 (L02,4) (Lessee Entries with Residual Value) The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee...
Instructions
(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 and reversing entries are used when appropriate.
P21-7 (L02,4) GROUPWORK (Lessee Entries and Balance Sheet Presentation, Capital Lease) Ludwick Steel Company as lessee signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of $40,000 are to be made at the beginning of each lease year (December 31). The taxes, insurance, and the maintenance costs are the obligation of the lessee. The interest rate used by the lessor in setting the payment schedule is 9%; Ludwick’s incremental borrowing rate is 10%. Ludwick is unaware of the rate being used by the lessor. At the end of the lease, Ludwick has the option to buy the equipment for $1, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Ludwick uses the straight-line method of depreciation on similar owned equipment.
Instructions
(a) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2017, by Ludwick.
(b) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2018, by Ludwick.
(Prepare the lease amortization schedule for all five payments.)
(c) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2019, by Ludwick.
(d) What amounts would appear on Ludwick’s December 31, 2019, balance sheet relative to the lease arrangement?
P21-8 (L02,4) (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 doubledeclining- 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
(a) Explain the probable relationship of the $550,000 amount to the lease arrangement.
(b) Prepare the journal entry or entries that should be recorded on January 1, 2017, by Cage Company.
(c) Prepare the journal entry to record depreciation of the leased asset for the year 2017.
(d) Prepare the journal entry to record the interest expense for the year 2017.
(e) Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made.
(f) What amounts will appear on the lessee’s December 31, 2017, balance sheet relative to the lease contract?
P21-9 (L02) (Lessee Entries, Capital Lease with Monthly Payments) Shapiro Inc. was incorporated in 2016 to operate as a computer software service firm with an accounting fiscal year ending August 31. Shapiro’s primary product is a sophisticated online inventory-control system; its customers pay a fixed fee plus a usage charge for using the system.
Shapiro has leased a large, Alpha-3 computer system from the manufacturer. The lease calls for a monthly rental of $40,000 for the 144 months (12 years) of the lease term. The estimated useful life of the computer is 15 years.
Each scheduled monthly rental payment includes $3,000 for full-service maintenance on the computer to be performed by the manufacturer. All rentals are payable on the first day of the month beginning with August 1, 2017, the date the computer was installed and the lease agreement was signed. The lease is noncancelable for its 12-year term, and it is secured only by the manufacturer’s chattel lien on the Alpha-3 system.
This lease is to be accounted for as a capital lease by Shapiro, and it will be depreciated by the straight-line method with no expected salvage value. Borrowed funds for this type of transaction would cost Shapiro 12% per year (1% per month). Following is a schedule of the present value of $1 for selected periods discounted at 1% per period when payments are made at the beginning of each period…
Instructions
Prepare all entries Shapiro should have made in its accounting records during August 2017 relating to this lease. Give full explanations and show supporting computations for each entry. Remember, August 31, 2017, is the end of Shapiro’s fiscal accounting period and it will be preparing financial statements on that date. Do not prepare closing entries. (AICPA adapted)
P21-10 (L03,4) GROUPWORK (Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual
Value) 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
(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.
(1) Lease receivable.
(2) Sales price.
(3) Cost of sales.
(b) Prepare a 10-year lease amortization schedule.
(c) Prepare all of the lessor’s journal entries for the first year.
P21-11 (L02,4) (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%.
Instructions
(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.
(b) Prepare a 10-year lease amortization schedule.
(c) Prepare all of the lessee’s journal entries for the first year. Assume straight-line depreciation.
P21-12 (L02,4) (Basic Lessee Accounting with Difficult PV Calculation) In 2016, Grishell Trucking Company negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were erected to the company’s specifications on land owned by the company. On January 1, 2017, Grishell Trucking Company took possession of the lease properties. On January 1, 2017 and 2018, the company made cash payments of $948,000 that were recorded as rental expenses.
Although the terminals have a composite useful life of 40 years, the noncancelable lease runs for 20 years from January 1, 2017, with a bargain-purchase option available upon expiration of the lease.
The 20-year lease is effective for the period January 1, 2017, through December 31, 2036. Advance rental payments of $800,000 are payable to the lessor on January 1 of each of the first 10 years of the lease term. Advance rental payments of $320,000 are due on January 1 for each of the last 10 years of the lease. The company has an option to purchase all of these leased facilities for $1 on December 31, 2036. It also must make annual payments to the lessor of $125,000 for property taxes and $23,000 for insurance. The lease was negotiated to assure the lessor a 6% rate of return.
Instructions
(a) Prepare a schedule to compute for Grishell Trucking Company the present value of the terminal facilities and related obligation at January 1, 2017.
(b) Assuming that the present value of terminal facilities and related obligation at January 1, 2017, was $7,600,000, prepare journal entries for Grishell Trucking Company to record the:
(1) Cash payment to the lessor on January 1, 2019.
(2) Amortization of the cost of the leased properties for 2019 using the straight-line method and assuming a zero salvage value.
(3) Accrual of interest expense at December 31, 2019.
Selected present value factors are as follows...
(AICPA adapted)
P21-13 (L03,4) (Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is $411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be $15,000. The hospital will pay rents of $60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of $250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.
Instructions
(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.
(1) Lease receivable at inception of the lease.
(2) Sales price.
(3) Cost of sales.
(b) Prepare a 10-year lease amortization schedule.
(c) Prepare all of the lessor’s journal entries for the first year.
P21-14 (L02,4) (Lessee Computations and Entries, Capital Lease with Guaranteed Residual Value) Assume the same data as in P21-13 and that Chambers Medical Center has an incremental borrowing rate of 10%.
Instructions
(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.
(b) Prepare a 10-year lease amortization schedule.
(c) Prepare all of the lessee’s journal entries for the first year.
P21-15 (L02,4) WRITING (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. Rental of $3,240 per year (at the end of each year). (The present value at 8% per year is $10,731.)
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. Estimated economic life of the automobile is 5 years.
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.)
P21-16 (L02,3,4) GROUPWORK (Lessee-Lessor Accounting for Residual Values) Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.
1. The lease term is 10 years, noncancelable, and requires equal rental payments of $30,300 due at the beginning of each year starting January 1, 2017.
2. The equipment has a fair value and cost at the inception of the lease (January 1, 2017) of $220,404, an estimated economic life of 10 years, and a residual value (which is guaranteed by Goring Dairy) of $20,000.
3. The lease contains no renewable options, and the equipment reverts to King Finance Company upon termination of the lease.
4. Goring Dairy’s incremental borrowing rate is 9% per year. The implicit rate is also 9%.
5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.
6. 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) Evaluate the criteria for classification of the lease, and describe the nature of the lease. In general, discuss how the lessee and lessor should account for the lease transaction.
(b) Prepare the journal entries for the lessee and lessor at January 1, 2017, and December 31, 2017 (the lessee’s and lessor’s year-end). Assume no reversing entries.
(c) What would have been the amount capitalized by the lessee upon the inception of the lease if:
(1) The residual value of $20,000 had been guaranteed by a third party, not the lessee?
(2) The residual value of $20,000 had not been guaranteed at all?
(d) On the lessor’s books, what would be the amount recorded as the Net Investment (Lease Receivable) at the inception of the lease, assuming:
(1) The residual value of $20,000 had been guaranteed by a third party?
(2) The residual value of $20,000 had not been guaranteed at all?
(e) Suppose the useful life of the milking equipment is 20 years. How large would the residual value have to be at the end of 10 years in order for the lessee to qualify for the operating method? (Assume that the residual value would be guaranteed by a third party.) (Hint: The lessee’s annual payments will be appropriately reduced as the residual value increases.)
