ACCTG472_A5_sol

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Apr 3, 2024

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Page 1 THE PENNSYLVANIA STATE UNIVERSITY Accounting 472 Intermediate Financial Accounting II – Spring 2024 Assignment #5 GENERAL INSTRUCTIONS: This assignment is due on Thursday, March 21 st at 8:00 p.m. Please submit the assignment in class or directly in the appropriate box in the Accounting Department office. Include your full name and student ID# on the first page of your assignment. Note that late assignments will not be accepted. Problem #1 No Residual Value Lease Sampson Leasing Incorporated entered into a lease with Southern Outdoors Corporation (the lessee). The terms of the lease and information about the equipment being leased include: Lease term and estimated economic life of the equipment 4 years Estimated residual value at end of lease $0 Sampson’s cost of the equipment $20,000 Fair value of equipment on inception date $24,000 Implicit interest rate (known to Southern Outdoors) 5% Southern Outdoors’ incremental borrowing rate 6% The first lease payment occurs on January 1, 2023 (date of lease inception). All subsequent lease payments occur on December 31. Assume both parties use straight-line depreciation. REQUIRED: 1. Compute the annual rental payments on the lease. 2. What type of lease is this for Sampson and Southern Outdoors? (Support your answer using the required tests.) 3. Prepare the lease amortization schedule and the journal entries for 2023 for both the lessor and the lessee. Problem #2 Guaranteed Residual Value Lease by a Third Party Sampson Leasing Incorporated entered into a lease with the Home Repair Corporation. The terms of the lease and information about the equipment being leased include: Lease term 4 years Estimated economic life of the equipment 6 years Estimated residual value at end of lease $12,000 The residual value is guaranteed by a third party to the lease Sampson’s cost of the equipment (same as fair value) $48,000 Implicit interest rate (known to Southern Outdoors) 5% Home Repair’s incremental borrowing rate 6%

Page 2 The first lease payment occurs on January 1, 2023 (date of lease inception). All subsequent lease payments occur on December 31. No significant uncertainty exists regarding the collectability of the lease payments. REQUIRED: 1. Compute the annual rental payments on the lease. 2. What type of lease is this for Sampson and Home Repair? (Support your answer using the required tests.) 3. Prepare the journal entries for 2023 for both the lessor and the lessee. Problem #3 Newly Recognized Operating Leases and Financial Ratios At the end of 2018, Microsoft had a significant number of leases structured as operating leases that were affected by the new lease standard. Consider how the new lease standard changes certain financial ratios. Use the operating asset and lease amounts discussed in the class notes to complete the problem. REQUIRED: How did the accounting change for operating leases affect the following financial ratios (ignore the exact dollar amounts; just indicate whether the ratio would increased or decreased and why the change occurred)? - Debt to equity - Debt ratio (i.e., debt to total assets) - Cash flow per share - Earnings per share (explain the early years of the lease and the later years in the lease) (That is, consider what happens to rent expense for an operating lease under the old standard versus interest expense and amortization expense under the new standard). Problem #4 Bargain Purchase Option On January 1, 2023, Ohio Supply Company leased equipment from Jones Manufacturing Corporation. The lease term requires Ohio Supply to make equal annual lease payments on January 1, 2023 and then December 31, 2023 through December 31, 2025 (i.e., the lease term is four years). The estimated economic life of the asset and residual value are five years and $40,000, respectively. The estimated residual value at the end of the asset’s economic life is $10,000. Ohio Supply Company uses straight-line depreciation. The cost and fair value of the equipment is $450,000. The lease allows Ohio Supply to purchase the equipment for $5,000 at the end of the lease term. The implicit interest rate and incremental borrowing rates are both 6%. There are no important cost or collection uncertainties for Jones Manufacturing Corporation. REQUIRED: 1. Compute the annual rental payments on the lease. 2. What type of lease is this for Ohio Supply and Jones Manufacturing? (Support your answer using the required tests.) 3. Prepare the journal entries for 2023 for both parties.

Page 3 Problem #1 Requirement 1 Rental payments = $24,000 – ($0) = $6,445.98 3.723248 (The PVAD factor is for i =5%; n =4.) Requirement 2 Test #1 No, asset is returned to lessor at the end of the least term. Test #2 No, the lease does not contain a BPO. Test #3 Yes, the ratio of lease term to economic life is 4/4 years = 100% Test #4 Yes, present value of lease payments to fair value is: The 90% test: ($6,445.98 x 3.723248) = $24,000 $24,000 / $24,000 = 100% Test #5 No, the asset is not specialized. For Sampson, this is a sales-type lease with selling profit because the fair market value differs from the cost. For Southern Outdoors, this a finance lease. The lease amortization schedule is: Date Payment Effective Interest (5%) Balance decline Balance 1/1/23 $24,000.00 1/1/23 $6,445.98 0 $6,445.98 $17,554.02 12/31/23 $6,445.98 $877.70 $5,568.28 $11,985.73 12/31/24 $6,445.98 $599.29 $5,846.70 $6,139.03 12/31/25 $6,445.98 $306.95 $6,139.03 $0.00 Requirement 3 Lessee January 1, 2023 Right-of-use asset $24,000.00 Lease payable $24,000.00 Lease payable $6,445.98 Cash $6,445.98

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Page 4 December 31, 2023 Amortization expense ($24,000 - $0) / 4 years $6,000.00 Right-of-use asset $6,000.00 Interest expense $877.70 Lease payable $5,568.28 Cash $6,445.98 Lessor January 1, 2023 Lease receivable $24,000.00 Cost of goods sold $20,000.00 Sales revenue $24,000.00 Inventory of equipment $20,000.00 Cash $6,445.98 Lease receivable $6,445.98 December 31, 2023 Cash $6,445.98 Interest revenue $877.70 Lease receivable $5,568.28 Problem #2 Requirement 1 Rental payments = $48,000 – ($12,000 x 0.822702) = $10,240.41 3.723248 (The PV$ and PVAD factors are for i =5%; n =4.) Requirement 2 Sampson (lessor) Test #1 No, asset is returned to lessor at the end of the least term. Test #2 No, the lease does not contain a BPO. Test #3 No, the ratio of lease term to economic life is 4/6 years = 67% Test #4 Yes, present value of lease payments to fair value is: The 90% test: ($10,240.41 x 3.723248) + ($12,000 x 0.822702) = $48,000 $48,000 / $48,000 = 100% Test #5 No, the asset is not specialized.

Page 5 For Sampson, this is a finance lease because the residual is guaranteed by a third party. Home Repair (lessee) Test #1 No, asset is returned to lessor at the end of the least term. Test #2 No, the lease does not contain a BPO. Test #3 No, the ratio of lease term to economic life is 4/6 years = 67% Test #4 No, present value of lease payments to fair value is: The 90% test: ($10,240.41 x 3.723248 = $38,127.57 $38,127.57 / $48,000 = 79% Test #5 No, the asset is not specialized. For Home Repair, this an operating lease. Requirement 3 Sampson (lessor) January 1, 2023 Lease receivable $48,000.00 Inventory of equipment $48,000.00 Cash $10,240.41 Lease receivable $10,240.41 December 31, 2023 Cash $10,240.41 Interest revenue (($48,000-$10,240.41) x 5%) $1,887.98 Lease receivable $8,352.43 Home Repair (lessee) January 1, 2023 Right-of-use asset $38,127.57 Lease payable $38,127.57 Lease payable $10,240.41 Cash $10,240.41 December 31, 2023 Interest Expense (($38,127.57-10, 240.41) x 5%) $1,394.36 Lease payable $8,846.05 Cash $10,240.41 Amortization Expense ($10,240.4-$1,394.36) $8,846.05 Right-of-use asset $8,846.05

Page 6 Problem #3 Debt to equity : The ratio would increase as the lease payable is now included in Microsoft’s debt. Microsoft’s equity would be largely unchanged as the lease payable and right-of-use asset amounts are close in value and have an offsetting effect on reported equity. Debt ratio : The ratio would increase as the lease payable is now included in Microsoft’s debt. , which would have a greater effect on the ratio than the right-of-use asset amount being included in Microsoft’s assets. This occurs as Microsoft’s debt is less than their total assets. Cash flow per share : The ratio would be unchanged. The cash payments are the same under the old and new standards. The number of shares does not change. Earnings per share : Earnings per share is unchanged. Under the old standard rent expense was recognized for the amount of the lease payment. Under the new standard, the sum of interest expense and amortization expense, which equals the amount of the lease payment, is recognized as lease expense. Problem #4 Requirement 1 Rental payments = $450,000 – ($5,000 x 0.792094) = $121,436.99 3.673012 (The PV$ and PVAD factors are for i =6%; n =4.) Requirement 2 Test #1 Yes, the asset is not expected to be returned to lessor at the end of the least term. Test #2 Yes, the lease contains a BPO. Test #3 Yes, the ratio of (extended) lease term to economic life is 5/5 years = 100% Test #4 Yes, present value of lease payments to fair value is: The 90% test: ($121,436.99 x 3.673012) + ($5,000 x 0.792094) = $450,000.00 $450,000.00 / $450,000.00 = 100% Test #5 No, the asset is not specialized. For Jones Manufacturing, this is a sales-type lease without profit. For Ohio Supply, this is a finance lease.

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Page 7 The lease amortization schedule is: Date Payment Effective Interest (7%) Balance decline Balance 1/1/23 $450,000.00 1/1/23 $121,436.99 0 $121,436.99 $328,563.01 12/31/23 $121,436.99 $19,713.78 $101,723.21 $226,839.79 12/31/24 $121,436.99 $13,610.39 $107,826.61 $119,013.18 12/31/25 $121,436.99 $7,140.79 $114,296.20 $4,716.98 12/31/26 $5,000.00 $283.02 $4,716.98 $0.00 Requirement 3 Lessee January 1, 2023 Right-of-use asset $450,000.00 Lease payable $450,000.00 Lease payable $121,436.99 Cash $121,436.99 December 31, 2023 Amortization expense ($450,000 - $10,000) / 5 years $88,000.00 Right-of-use asset $88,000.00 Interest expense $19,713.78 Lease payable $101,723.21 Cash $121,436.99 Lessor January 1, 2023 Lease receivable $450,000.00 Inventory of equipment $450,000.00 Cash $121,436.99 Lease receivable $121,436.99 December 31, 2023 Cash $121,436.99 Interest revenue $19,713.78 Lease receivable $101,723.21