101. On December 31, 2018, Burton, Inc. leased machinery with a fair value of $1,575,000 from Cey Rentals Co. The agreement is a six-year noncancelable lease requiring annual payments of $300,000 beginning December 31, 2018. The lease is appropriately accounted for by Burton as a capital lease. Burton’s incremental borrowing rate is 11%. Burton knows the interest rate implicit in the lease payments is 10%.
The present value of an annuity due of 1 for 6 years at 10% is 4.7908.
The present value of an annuity due of 1 for 6 years at 11% is 4.6959.
In its December 31, 2018 balance sheet, Burton should report a lease liability of
a. $1,137,240.
b. $1,275,000.
c. $1,408,770.
d. $1,437,240.
102. On December 31, 2018, Harris Co. leased a machine from Catt, Inc. for a five-year period. Equal annual payments under the lease are $2,100,000 (including $100,000 annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2018, and the second payment was made on December 31, 2019. The five lease payments are discounted at 10% over the lease term. The present value of minimum lease payments at the inception of the lease and before the first annual payment was $8,340,000. The lease is appropriately accounted for as a capital lease by Harris. In its December 31, 2019 balance sheet, Harris should report a lease liability of
a. $6,340,000.
b. $6,240,000.
c. $5,706,000.
d. $4,974,000.
103. A lessee had a ten-year capital lease requiring equal annual payments. The reduction of the lease liability in year 2 should equal
a. the current liability shown for the lease at the end of year 1.
b. the current liability shown for the lease at the end of year 2.
c. the reduction of the lease liability in year 1.
d. one-tenth of the original lease liability.
On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%.
104. In its 2018 income statement, what amount of interest expense should Hernandez report from this lease transaction?
a. $0
b. $135,000
c. $150,000
d. $180,000
On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a capital lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%.
105. In its 2018 income statement, what amount of depreciation expense should Hernandez report from this lease transaction?
a. $300,000
b. $240,000
c. $180,000
d. $120,000
106. In a lease that is recorded as a sales-type lease by the lessor, interest revenue
a. should be recognized in full as revenue at the lease’s inception.
b. should be recognized over the period of the lease using the straight-line method.
c. should be recognized over the period of the lease using the effective interest method.
d. does not arise.
107. Torrey Co. manufactures equipment that is sold or leased. On December 31, 2018, Torrey leased equipment to Dalton for a five-year period ending December 31, 2023, at which date ownership of the leased asset will be transferred to Dalton. Equal payments under the lease are $1,100,000 (including $100,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2018. Collectibility of the remaining lease payments is reasonably assured, and Torrey has no material cost uncertainties. The normal sales price of the equipment is $3,850,000, and cost is $3,000,000. For the year ended December 31, 2018, what amount of income should Torrey realize from the lease transaction?
a. $850,000
b. $1,100,000
c. $1,150,000
d. $1,650,000
*108. Jamar Co. sold its headquarters building at a gain, and simultaneously leased back the building. The lease was reported as a capital lease. At the time of the sale, the gain should be reported as
a. operating income.
b. comprehensive income net of income tax.
c. a separate component of stockholders’ equity.
d. a deferred gain.
*109. On December 31, 2018, Haden Corp. sold a machine to Ryan and simultaneously leased it back for one year. Pertinent information at this date follows:
Sales price $1,080,000
Carrying amount 990,000
Present value of reasonable lease rentals
($9,000 for 12 months @ 12%) 102,000
Estimated remaining useful life 12 years
In Haden’s December 31, 2018 balance sheet, the deferred profit from the sale of this machine should be
a. $102,000.
b. $90,000.
c. $12,000.
d. $0.
BRIEF EXERCISES
BE. 21-110—Capital lease (Essay).
Explain the procedures used by the lessee to account for a capital lease.
BE. 21-111—Capital lease amortization and journal entries.
Hughey Co. as lessee records a capital lease of machinery on January 1, 2018. The seven annual lease payments of $875,000 are made at the end of each year. The present value of the lease payments at 10% is $4,260,000. Hughey uses the effective-interest method of amortization and sum-of-the-years’-digits depreciation (no residual value).
Instructions (Round to the nearest dollar.)
(a) Prepare an amortization table for 2018 and 2019.
(b) Prepare all of Hughey’s journal entries for 2018.
BE. 21-112—Operating lease.
Maris Co. purchased a machine on January 1, 2018, for $2,500,000 for the express purpose of leasing it. The machine is expected to have a five-year life, no salvage value, and be depreciated on a straight-line monthly basis. On April 1, 2018, under a cancelable lease, Maris leased the machine to Dunbar Company for $750,000 a year for a four-year period ending March 31, 2022. Maris incurred total maintenance and other related costs under the provisions of the lease of $25,000 relating to the year ended December 31, 2018. Harley paid $750,000 to Maris on April 1, 2018.
Instructions [Assume the operating method is appropriate for parts (a) and (b).]
(a) Under the operating method, what should be the income before income taxes derived by Maris Co. from this lease for the year ended December 31, 2018?
(b) What should be the amount of rent expense incurred by Dunbar from this lease for the year ended December 31, 2018?
EXERCISES
Ex. 21-113—Lease criteria for classification by lessor.
What are the criteria that must be satisfied for a lessor to classify a lease as a direct-financing or sales-type lease?
Ex. 21-114—Direct-financing lease (essay).
Explain the procedures used to account for a direct-financing lease.
Ex. 21-115—Lessor accounting—sales-type lease.
Hayes Corp. is a manufacturer of truck trailers. On January 1, 2018, Hayes Corp. leases ten trailers to Lester Company under a six-year noncancelable lease agreement. The following information about the lease and the trailers is provided:
1. Equal annual payments that are due on January 1 each year provide Hayes Corp. with an 8% return on net investment (present value factor for 6 periods at 8% is 4.99271).
2. Titles to the trailers pass to Lester at the end of the lease.
3. The fair value of each trailer is $60,000. The cost of each trailer to Hayes Corp. is $54,000. Each trailer has an expected useful life of nine years.
4. Collectibility of the lease payments is reasonably predictable and there are no important uncertainties surrounding the amount of costs yet to be incurred by Hayes Corp.
Ex. 21-115 (cont.)
Instructions
(a) What type of lease is this for the lessor? Discuss.
(b) Calculate the annual lease payment. (Round to nearest dollar.)
(c) Prepare a lease amortization schedule for Hayes Corp. for the first three years.
(d) Prepare the journal entries for the lessor for 2018 to record the lease agreement, the receipt of the lease rentals, and the recognition of revenue (assume the use of a perpetual inventory method and round all amounts to the nearest dollar).
*Ex. 21-116—Lessee and lessor accounting (sale-leaseback).
On January 1, 2018, Morris Company sells land to Lopez Corporation for $10,000,000, and immediately leases the land back. The following information relates to this transaction:
1. The term of the noncancelable lease is 20 years and the title transfers to Morris Company at the end of the lease term.
2. The land has a cost basis of $8,400,000 to Morris.
3. The lease agreement calls for equal rental payments of $943,074 at the beginning of each year.
4. The land has a fair value of $10,000,000 on January 1, 2018.
5. The incremental borrowing rate of Morris Company is 10%. Morris is aware that Lopez Corporation set the annual rentals to ensure a rate of return of 8%.
6. Morris Company pays all executory costs which total $255,000 in 2018.
7. Collectibility of the rentals 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 for the entire year 2018 on the books of Morris Company to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.)
(b) Prepare the journal entries for the entire year 2018 on the books of Lopez Corporation to reflect the above purchase and lease transactions.
*Ex. 21-117—Sale-leaseback.
On January 1, 2018, Hester Co. sells machinery to Beck Corp. at its fair value of $960,000 and leases it back. The machinery had a carrying value of $840,000, the lease is for 10 years and the implicit rate is 10%. The lease payments of $142,000 start on January 1, 2018. Hester uses straight-line depreciation and there is no residual value.
Instructions
(a) Prepare all of Hester’s entries for 2018.
(b) Prepare all of Beck’s entries for 2018.
PROBLEMS
Pr. 21-118—Lessee accounting—capital lease.
Eubank Company, as lessee, enters into a lease agreement on July 1, 2018, for equipment. The following data are relevant to the lease agreement:
1. The term of the noncancelable lease is 4 years, with no renewal option. Payments of $978,446 are due on July 1 of each year.
2. The fair value of the equipment on July 1, 2018 is $3,500,000. The equipment has an economic life of 6 years with no salvage value.
3. Eubank depreciates similar machinery it owns on the sum-of-the-years’-digits basis.
4. The lessee pays all executory costs.
5. Eubank’s incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 8% in computing the lease payments (present value factor for 4 periods at 8%, 3.57710; at 10%, 3.48685).
Instructions
(a) Indicate the type of lease Eubank Company has entered into and what accounting treatment is applicable.
(b) Prepare the journal entries on Eubank’s books that relate to the lease agreement for the following dates: (Round all amounts to the nearest dollar. Include a partial amortization schedule.)
1. July 1, 2018.
2. December 31, 2018.
3. July 1, 2019.
4. December 31, 2019.
Pr. 21-119—Lessee accounting—capital lease.
Krause Company on January 1, 2018, enters into a five-year noncancelable lease, with four renewal options of one year each, for equipment having an estimated useful life of 10 years and a fair value to the lessor, Daly Corp., at the inception of the lease of $4,000,000. Krause’s incremental borrowing rate is 8%. Krause uses the straight-line method to depreciate its assets. The lease contains the following provisions:
1. Rental payments of $292,000 including $26,000 for property taxes, payable at the beginning of each six-month period.
2. A termination penalty assuring renewal of the lease for a period of four years after expiration of the initial lease term.
3. An option allowing the lessor to extend the lease one year beyond the last renewal exercised by the lessee.
4. A guarantee by Krause Company that Daly Corp. will realize $200,000 from selling the asset at the expiration of the lease. However, the actual residual value is expected to be $120,000.
Instructions
(a) What kind of lease is this to Krause Company?
(b) What should be considered the lease term?
(c) What are the minimum lease payments?
(d) What is the present value of the minimum lease payments? (PV factor for annuity due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for amount due in 20 semi-annual interest periods at 8% annual rate, .45639.) (Round to nearest dollar.)
(e) What journal entries would Krause record during the first year of the lease? (Include an amortization schedule through 1/1/19 and round to the nearest dollar.)
Pr. 21-120—Lessor accounting—direct-financing lease.
Lucas, Inc. enters into a lease agreement as lessor on January 1, 2018, to lease an airplane to National Airlines. The term of the noncancelable lease is eight years and payments are required at the end of each year. The following information relates to this agreement:
1. National Airlines has the option to purchase the airplane for $16,000,000 when the lease expires at which time the fair value is expected to be $27,000,000.
2. The airplane has a cost of $68,000,000 to Lucas, an estimated useful life of fourteen years, and a salvage value of zero at the end of that time (due to technological obsolescence).
3. National Airlines will pay all executory costs related to the leased airplane.
4. Annual beginning of year lease payments of $9,563,671 allow Lucas to earn an 8% return 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 Lucas.
Instructions
(a) What type of lease is this? Discuss.
(b) Prepare a lease amortization schedule for the lessor for the first two years (2018-2019). (Round all amounts to nearest dollar.)
(c) Prepare the journal entries on the books of the lessor to record the lease agreement, to reflect payments received under the lease, and to recognize revenue, for 2018.
IFRS QUESTIONS
True/False
1. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5.
2. IFRS for leases is more “rules-based” than GAAP and includes many bright-line criteria to determine ownership.
3. IFRS requires lessees to use their incremental rate, unless the implicit rate is known by the lessee and the implicit rate is lower than the incremental rate.
4. IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.
5. Because IFRS is very general in its provisions for lease accounting, the required disclosures for leases under IFRS are more detailed and extensive than those required under GAAP.
Multiple Choice
6. Which of the following statements is true when comparing the accounting for leasing transactions under GAAP with IFRS?
a. IFRS requires that companies provide a year-by-year breakout of future noncancelable lease payments due in years 1 through 5.
b. IFRS for leases is more “rules-based” than GAAP and includes many bright-line criteria to determine ownership.
c. The IFRS leasing standard is the subject of over 30 interpretations since its issuance in 1982.
d. IFRS does not provide detailed guidance for leases of natural resources, sale-leasebacks, and leveraged leases.
7. Which of the following is a one of the criteria for recording a lease as a finance lease, under IFRS?
a. The lease term is for the major part of the economic life of the asset.
b. The lease must be cancelable.
c. The lease doesn’t contain a bargain-purchase option.
d. The present value of the minimum lease payments amounts to 75% of the fair value of the leased asset.
8. Which of the following statement is true?
a. Operating leases under GAAP are referred to as finance leases under IFRS.
b. IFRS has an additional lessor criterion for capitalization that collectability of the payments required from the lessee is reasonably predictable.
c. IFRS is more general in its provisions for determining if a lease arrangement transfers the risks and rewards of ownership.
d. Under IFRS, in computing the present value of the minimum lease payments, the lessee is required to use the incremental borrowing rate.
