Connect_CH15

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Regis University *

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4110

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Accounting

Date

Apr 3, 2024

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CHAPTER 15- LESSEE -Possible reasons for leasing an asset rather than purchasing: lower periodic payments on the asset; tax benefits; fear of obsolescence; and insufficient cash flow -Lease can be accounted for by ways of rental agreement; or as a purchase/sale agreement with debt financing -Operating Lease: A lease in which the rights and responsibilities of ownership are retained by the lessor. -In an operating lease, interest expense plus amortization expense is equal to the straight-line lease payment. - A lease that is truer to the nature of a rental agreement is called an operating lease. -In an operating lease, the lessee reports lease expense and the lessor reports lease revenue, both on a straight-line basis. -For an operating lease, the lessee will report a single lease expense -In an operating lease, the lessor reports the leased asset on their balance sheet -The lessee's payment in an operating lease is allocated between interest expense and amortization for the right-of-use asset and reported as a single lease expense -In its income statement, the lessee combines interest expense and amortization expense into a single lease expense amount reported as a straight-line amount each period when account for an operating lease. -Depending on the nature of the leasing arrangement, a lease is accounted for as a rental or a purchase/sale - The lease term is typically considered to be: the contractual term of the lease and any periods covered by options to extend if extension is reasonably certain to occur. - When are the right-of-use asset and lease liability remeasured and adjusted for changes in the amount of payments due to a change in index or rate? -When the lease is modified giving the lessee an additional right of use and when the lease term is reassessed and changed -The lease term includes any periods covered by options to extend with significant incentive and the contractual term of the lease. -Leasehold improvements would justify reassessment of a lease term.

- If a lease payment depends on an index or rate, any change in the lease payments due to changes in that index or rate 1) are used to calculate the right-of-use asset and lease liability only if they are remeasured for another reason; 2) is reported as additional lease expense for the lessee and lease revenue for the lessor. - If a lease is modified and is reclassified from an operating to a sales-type lease, the lessor will record interest revenue at the straight-line rate instead of the effective rate. - If a lease is modified and is reclassified from an operating to a sales-type lease, the lessor will record interest revenue at the effective rate, instead of the straight-line. - If a lease modification substantially lengthens the amount of time the lessee has the right to use an asset, it is possible that the lessee might need to switch its lease classification from operating to finance. -A lease is classified as a finance lease by the lessee and a sales-type lease by the lessor if the present value of lease payments including any lessee-guaranteed residual value constitutes "substantially all" of the fair value of the asset. -Residual value is an estimate of a leased asset's commercial value at the end of the lease term. -When a leased asset is returned at the end of the lease term and the actual residual value is less than the initial estimated residual value, the lessor records a loss for the difference between estimate and actual. - The present value of a residual asset in a lease reduces the lessee’s lease payments regardless of guarantee; and provides a source of recovery of the lessor’s investment regardless of guarantee -The lessor's gross investment in the lease is the total of periodic rental payments plus any residual value - The guaranteed residual value is a commitment by the lessee that the lessor will recover a specified residual value at the end of the lease term. -A guaranteed residual value is included the calculation of the present value of the lease payments when comparing that amount to the fair value of the asset in determining lease classification. -Sales revenue for the lessor does not include the expected residual value to be recovered. -How should the lessee account for an expected cash payment when the value of the leased asset at the end of the lease is expected to be less than the guaranteed residual value? Answer: The lessee should increase the right-of-use asset and lease liability by the present value of the expected cash payment

- FALSE that the residual value of a leased asset impacts the lessee's calculation of effective interest. Explained: The lessee's accounting is unaffected by the residual value other than it causes the lessee's payments to be lower -Periodic lease payments and residual value are included in the lessor’s gross investment in the lease. - How does a residual value in a finance/sales-type lease affect the lessee? Answer: The lessee lease payments are lower - How does a residual value in a finance/sales-type lease affect the lessor? Answer: The lessor includes the residual value in lease receivable computations regardless of guarantee. -The journal entry to record the lessor’s receipt of payment on a short-term lease would include credit to lease revenue. -Under the shortcut method, the lessee recognizes rent expense over the lease term -In a short-term lease, periodic rental payments are recorded as rent expense by the lessee and recorded as rent revenue by the lessor -If future lease payments are uncertain, they are considered as part of present value calculations only if they are in-substance fixed payments - The present value of the residual value is included from the lease receivable, and it is excluded from sales and cost of goods sold for the lessor. -Smith Company leased equipment from FirstLease Corp. The cost of the equipment to FirstLease was $500,000. The present value of the expected residual value is $40,000. The lease includes six annual payments beginning on the first day of the lease. If the six lease payments are of an equal amount, what payment amount would provide FirstLease Corp with a return of 10%? -Answer: $96,018 Reason: $500,000-40,000 = $460,000/4.79079 = $96,018 -Samuel Company leased equipment from Lease Corp. The cost of the equipment to Lease Corp was $300,000. Lease Corp will require Samuel to make the first payment on the day of the lease signing (January 1 of Year 1), with the next four payments due on January 1 of Years 2 - 5. At the end of Year 5, the equipment is expected to have a residual value of $50,000. The estimated useful life of the equipment is seven years. If the five lease payments are of an equal amount, what payment amount provides Lease Corp with a return of 6%? -Answer: $55,990 Reason: $300,000 - 50,000 = $250,000/4.46511 = $55,990 - Lease Corp leases equipment to Samuel Company in a sales-type lease. The present value of the lease payments is $250,000. The lease includes an unguaranteed residual value with a present value of $50,000. The rate implicit in the contract is 6% and the lease term is five years. Which

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of the following are included in the journal entry for Lease Corp to record this lease? Answer: Credit Equipment $5,000 -On January 1, Year 1, Samuel Company leases equipment from Lease Corp. The lease agreement specifies five annual payments of $50,000, with the first payment due at lease signing (January 1, Year 1), and at each January 1 from Year 2 to Year 5. At the end of the lease term, the equipment will be returned to the lessor and is expected to have a residual value of $30,000. The estimated useful life of the equipment is six years. The interest rate in the financing arrangement is 6%. The cost to Lease Corp of manufacturing the equipment is $150,000. The journal entry for the Lessor on January 1, Year 1 will include the following in its entry: Debit lease receivable $245,673 credit sales revenue $223,255 and credit equipment $150,000 Reason for lease receivable calculation: PV of payments: $50,000 x 4.46511 = $223,255 plus the PV of residual: $30,000 x 0.74726 = $22,418 = $245,673 - On January 1, 20X1, Mitchell Company leases equipment from Donelson Corp. for the equipment’s entire useful life of six years. Donelson acquired the asset for $239,826 and normally utilizes an 5% interest rate for these types of transactions. The annual lease payment is $45,000. Mitchell should recognize the first lease payment on January 1, 20X1 by debiting lease payable for $45,000 - On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over the equipment's entire estimated useful life of five years. Franz acquired the asset for $431,213 and normally utilizes an interest rate of 8% for these types of transactions. The annual rental payment is $100,000; the first payment is due on January 1, 20X1. At the commencement of the lease, Tucker should debit right-of-use asset for $500,000 and credit lease payable for $431,213 (PV of lease payments). AND Franz should debit lease receivable $431,213 and credit equipment for $431,213 (book value of the asset). -Tucker should recognize the first lease payment on January 1, 20X1 by debiting lease payable and crediting cash for $100,000. AND Franz should debit and credit deferred lease revenue for $100,000 -Taylor Company leased an asset from Lease Corp. using an operating lease for equipment with a useful life of seven years. The initial lease term was for three years. After two years, Taylor Company and Lease Corp. agree to extend the lease term by four years, and to change the amount of lease payments. The additional four years were not originally an option. The increase in present value of lease payments for Taylor is $200,000. The present value of the remaining lease payments for Lease Corp is $300,000. The initial cost of the equipment to Lease Corp was $500,000. The useful life of the equipment is estimated to be seven years and depreciation is computed straight-line with no residual value. How should Lease Corp account for this lease modification? -debit cost of goods sold for $357,143; debit accumulated depreciation for $142,857; debit lease receivable for $300,000; credit asset $500,000; credit sales revenue for $300,000 Same question continued: --How should Taylor account for this lease modification? -Debit right of use asset and credit lease payable for $200,000

- Taylor Company leased an asset from Lease Corp. using an operating lease for equipment with a useful life of seven years. The initial lease term was for three years. After two years, Taylor Company and Lease Corp. agree to extend the lease term by three years, and to change the amount of lease payments. The additional three years were not originally an option. How should Taylor address this lease modification? - Reclassify from an operating lease to a finance lease; Update the right-of-use asset for the increase in present value Question continued: How should Taylor address this lease modification? - Record a lease receivable for the present value of remaining lease payments and Reclassify from an operating lease to a sales-type lease On January 1, 20X1, Tucker Company leases equipment from Franz Inc. over three years of the equipment's five-year estimated useful life. Franz acquired the asset for $431,213 and normally utilizes an 8% interest rate for these types of transactions. The present value of the lease payments is $357,710. The annual lease payment is $100,000; the first payment is due on January 1, 20X1. Tucker should recognize the second lease payment by debiting lease payable $79,383 ( $100,000-$20,617) and interest expense for $20,617 ( ($357,710-$100,000)x.08). -Lease Corp leases equipment to Western Company in a sales-type lease. The present value of the lease payments is $450,000. The lease includes an unguaranteed residual value with a present value of $50,000. Which of the following complete the journal entry for Lease Corp to record this lease? Answer: Debit lease receivable and credit equipment $500,00 - Ludwig Corporation leases a machine to Kluge Corporation under a three-year lease agreement determined to be a finance/sales-type lease. At the inception of the lease Kluge records a right- of-use asset and lease payable. Same question continued: --At the inception of the lease Ludwig Corp should record right of use asset. - The lessee records the right-of-use asset as the present value of lease payments. - In a typical finance lease, the first lease payment at the beginning of the lease consists of reduction in principle only - After the first lease payment, each lease payment in a finance lease consists of an amount representing interest and a reduction in the principal. -At the inception of a finance lease for computer equipment, the lessee should debit right of use asset and credit lease payable. - The right-of-use asset is amortized straight-line, unless the lessee's pattern of using the asset is different.

-Selling profit exists in a sales-type lease when the present value of the lease payments is greater than the cost of the asset. -Glueck Inc. leases an asset with a cost of $200,000 to Perl Company. The present value of the annual lease payments is $320,000 and control of the asset is transferred to Perl Company. At the commencement of the lease, Glueck should credit sales revenue for $320,000 and equipment for $200,000 -Fit Company leases building space from Lease Corp. Fit Company agrees to pay Lease Corp an additional amount if Lease Corp attracts a higher amount of traffic through the doors resulting in more profit for Fit Company. How are these variable lease payments treated? - Lease Corp records lease revenue when the variable lease payment is received and Fit Company records lease expense when the variable lease payment is paid -Match each calculation with the journal entry required for the lessor on a sales-type lease with a residual value.  Debit lease receivable  PV of lease payments plus the PV of the residual value  Debit cost of goods sold  Lessor's cost of the equipment less the PV of the residual value  Credit sales revenue  Sales less the PV of residual value  Credit Inventory  Lessor's cost of equipment - The present value of the residual value is included from the lease receivable, and it is excluded from sales and cost of goods sold for the lessor. -Sales revenue for the lessor does not include the expected residual value to be recovered. -When a leased asset is returned at the end of the lease term and the actual residual value is less than the initial estimated residual value, the lessor records a loss for the difference between estimate and actual. -A lease is classified as a finance lease by the lessee and a sales-type lease by the lessor if the present value of lease payments including any lessee-guaranteed residual value constitutes "substantially all" of the fair value of the asset. -FALSE: When a bargain purchase option is present, the lessor subtracts the future value of the exercise price from the amount to be recovered to determine the amount to be recovered through rental payments. REASON: The lessor subtracts the present value -Smith leases a piece of equipment from Marvin Company. The lease has a bargain purchase option which is expected to be exercised at the end of the lease. The useful life of the equipment is 10 years and the lease term is 8 years. Which number of years should be used to compute amortization? ANSWER: 10

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-When the lessee is given the option of purchasing the leased property at a price significantly lower than its fair value, a bargain purchase option is present. - If the lease term includes a bargain purchase option that is reasonably expected to be exercised, when does the lease term end for accounting purposes? ASNWER: When the option becomes exercisable -How does the bargain purchase option affect the calculation of the present value of the lease payments for the lessee? ASNWER: Increases. Reason: The present value of the exercise price is added to the present value of lease payments -The lessor subtracts the present value of a bargain purchase option price to determine the amount that must be recovered through the periodic rental payments. -The lessee adds the present value of the bargain purchase option to the present value of periodic rental payments when computing the amount to be recorded as a right-of-use asset and a lease liability.