Chapter 20

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Yorkville University *

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Jan 9, 2024

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Chapter 20 Question 1: A contract calls for Lessor Corporation to lease equipment to Lessee Corporation beginning January 1, 2020. Instructions a. Classify the lease contract Both IFRS and ASPE will capitalize lease contract b. Determine the present value of the lease payments (minimum lease payments) and the amount to be capitalized under IFRS (and ASPE). IFRS -> i= 10% -> implicate & it is known ASPE -> i= 10% -> power PV of annual lease payment - executory cost 25,981.62 – 2000 = 23,981.62 *change the setting on calculator to beginning* PMT = 23,981.62 N = 5% i= 10% PV = ? $ 100,000 + PV of payment at end of lease term 0 Asset $ 100,000 ASPE = PV us FV = 100,000 IFRS = 100,000

c. Prepare the related journal entries in 2020. IFRS ASPE Jan 01, 2020 Inception of contract Dr. Right to use asset 100,000 Cr. Cash 23,982 Cr. Lease liability 76,018 Dr. asset under Lease 100,000 Cr. Cash 23,982 Cr. obligation under lease 76,018 Dr. Prepaid maintenance 2000 Cr. cash 2000 Dec. 31, 2020 Depreciation Dr. Dep. Exp 20,000 Cr. Acc Deprecation 20,000 (100,000/5) = 20,000 ( 100k = asset value, 5 = lease term) IFRS ASPE Dec. 31, 2020 Interest Dr. interest expense 7602 Cr. Lease liability 7602 76,018 * 10% = Dr. interest expense 7602 Cr. obligation under lease 7602 Same I, used for PV. Total liability = 76018 + 7602 = 83,620 Non current Current non-current 23,982 59,638 Annual pmt Jan 01. d. Show the lease related account in December 31,2020 Classified balance sheet

e. Record journal entries elated to lease on Jan1,2021 in Lessee’s books under IFRS Dr. Lease liability 23982 will be repeated till end of the lease term Dr. prepaid maintenance 2000 Cr. cash 25982 Dec 31, 2021 Dep. Exp. 20,000 Cr. Acc. Dep 20,000 Dr. interest expense 59634 Cr. Lease liability 5964 Cr. f. Show the lease related account in December 31,2021 Classified balance sheet g. Assume that the lessee purchases the equipment at the end of the lease for $5,000, and expects to use it for another two years, Record the needed entry . Dr. Accu. Dep 100,000 Cr. Right to use asset 100,000 Dr. equipment 5000 Cr. Cash 5000

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Question 2:  Lessor wants to recover net investment of $100,000 and earn 10%. Asset reverts to lessor at end of 5-year lease term.  Expected residual value at end of lease is $5,000. The company use straight line method for depreciation  The Lessee corporation pays all executory costs directly to 3 rd party except for maintenance fees of $2,000 per year.  Lessee corporation’s incremental borrowing rate is 11% per year. Lessor Corporation set the annual rental to earn a rate of return on its investment of 10% per year, this fact is known to lessee Corporation.  The company is following ASPE. How to calculate annual lease payment if not given? - Lessor is the one who determines annual lease payments based on return of investment it wants to recover. - Net investment to be recovered 100,000 - Less: PV of residual value (deduct the amount despite guaranteed or unguaranteed) FV = 5000, n = 5, i= 10% (lower) (3104.6) PV of total lease payment 96,895.5 To calculate annual lease payment ( PMT) PV= 96,895.5, n =5, i= 10%, PMT = ?? [23,237] Instructions: 1) Calculate the annual lease payment

2) Record the journal entries in the lessee’s book assuming A) Residual value is guaranteed B) Residual value is not guaranteed 3) Show how the lease related accounts appear in the classified balance sheet at the end of the lease term assuming residual value is guaranteed and if not. Guaranteed Unguaranteed Value of Capitalized Assets and Liability Asset PV of annual lease $96,895 + PV of guaranteed residual value $3105 (FV=5000, n=5,i=10%) Dr. Asset under lease 100,000 Cr. Cash 23,237 Cr. obligation under lease 76,763 Dr. Prepaid maintenance 2000 Cr. cash 2000 PV of annual lease 96,895 + PV of residual 0 96895 Dr. Asset under lease 96895 Cr. Cash 23,237 Cr. Obligation under lease 73,762 Entry to record Inception of Contract Year End Depreciation Expense Dr. Dep. Exp. 19,000 Cr. Acc. Dep 19,000 (100,000 – 5000)/5 Dr. Dep. Exp. 19,379 Cr. Acc. Dep 19,379 (96,895 – 0)/5 Interest Expense Dr. interest expense 7676 Cr. obligation under lease 7676 76763*10% Dr. interest exp. 7366 Cr. obligation under lease 7366 73,658 * 10%

Balance Sheet At end of lease term (if guaranteed residual value) (if guaranteed residual value) Assets (ASPE) Equipment under lease $100,000 Less: Accumulated Depreciation ($95,000) $5,000 Liability Obligation under lease $5,000 Equipment under lease $96,895 Less: Acc. Depreciation ($96,895) Obligation under lease $0 4) Assume the asset was depreciated down to its residual value of $5,000; but the fair value at lease’s end was only $3,000. And the residual value was guaranteed Record the journal entry end of lease term Dr. Accumulated depreciation 95,000 Dr. Obligation under lease 5,000 Dr. Loss on Lease 2,000 Cr. Equipment under lease $100,000 Cr. Cash $2,000 (5,000 – 3,000) Since we are used the asset very heavily, the fair value is less than the residual value, therefore we are obligated to pay the difference. To balance the entry we have to debit the loss on lease account. 5) Assume the asset was depreciated down to its residual value of $5,000; but the fair value at lease’s end was only $3,000. And the residual value was unguaranteed. Record the journal entry at end of lease term Dr. Accumulated Depreciation $96,895 Cr. Equipment under lease $96,895

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6) Discuss how the journal entry would change If the fair value of leased assets at the end of lease term is more than $5,000 Gains on guaranteed residual values are shared between the lessor and lessee in whatever ratio the parties initially agreed to.

Question 3: Assume the annual lease payment for an operating/low-value lease is $239.82. Payment is made on Jan 1 of every year. Record the lease payment in Y1 assuming the company is following a) IFRS b) ASPE Naming under ASPE  Not operating lease  Operating lease Jan 1 Dr. Prepaid Rent 239.82 Cr. Cash 239.82 Dr. Rent expense 239.82 Cr. Prepaid rent 239.82 Dec 31, (adjusting entry) Dr. Low value lease expense 239.82 Cr. Prepaid Rent 239.82

Question 4: Instructions: 1) Classify the lease contract from lessor perspective Contract will be capitalized: 1. The asset will be leased all of its useful life (5 yrs.) 2. Collectability is assured The contact is accounted for using Direct finance/ Finance since FV = Cost *This is what must be written for the lessor, for full marks) 2) Calculate the initial gross investment in the lease, which is the amount to be recognized in Lease Receivable Lease receivable = lease payment ( net of executory cost, if included) * lease term + residual value Dr. Recoverable XX Cr. Asset under lease XX (25,982 – 2000) * 5 + 0 = $119,908

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3) Prepare all journal entries to be recorded by the lessor on January 1, 2020, relating to a. the acquisition of the asset by the lessor, b. its transfer to the lessee, the resulting receivable, the unearned interest income to be recorded, and c. the first payment to be received. d. Calculate the change in the “Net investment in lease” for Lessor during 2020 and the split between current and non-current asset amounts . Jan, 2020 Inception of Lease 23,982*5 Dr. lease receivable $119,908 Cr. Unearned interest income 19,908 Cr. Equipment under lease 100,000 Total interest income over the lease term Lease receivable 119,908 -unearned interest income (19,908) Net investment 100,000 Receipt of first payment Dr. Cash 23,982 Cr. Lease receivable 23,982 Dr. Cash 2,000 Cr. Maintenance Expense 2,000 Dec.31,2020 Dr. Unearned Interest income 7,602 Cr. Interest income 7,602 Lease payment (-) Interest Reduction CV Jan 1 100,000 (net investment) Jan 1 23,982 0 23,982 76,018 Dec 31, 2020 23,982 7602 (76018 * 10%) 16,380 59,638

Balance Sheet on Dec.31,2020 Current 23,982 -> received to m Non- current 59,638 4) Prepare the journal entries to be made by Lessor in 2021 and at the end of the lease. (Assume that the equipment is sold to Lessee for $5,000 when the lease expires.) Jan.1,2021 Dr. Cash 23,982 Cr. Lease receivable 23,982 Dr. Cash 2,000 Cr. Maintenance Expense 2,000 Lease payment Interest Reduction CV Dec. 31, 2020 23,982 7602 16380 76,019 Jan 01, 2021 23,982 5964 18,018 58,000 Dec. 31, 2021 Dr. Unearned Interest income 5964 Cr. Interest income 5964 Sale of equipment at end of lease term Dr. Cash 5,000 Cr. Gain on sale of equip. 5,000 Equipment is already removed from lessor books at beg, of the contract.

Question 5: • The lease has 5-year term that begins in Jan.1,2020 is non-cancellable and requires equal rental payment of $23,237.09. The PV of total lease payment is $96,895 • The leased equipment has an $85,000 cost to the manufacturer, Lessor Corporation. • The estimated residual value is $5,000 (the PV of which is $3,104.60) and the asset has 5 years useful life. • The leased asset’s actual fair value at the end of the lease is $3,000. • Collectability is reasonable assured, and no additional costs are incurred by Lessor • The interest rate implicit is the lease is 10%. Lessor corporation set the annual lease payments to ensure 10% return on its investment Instructions a. Classify the leasing contract from lessor perspective b. Prepare the journal entries under the guaranteed versus unguaranteed scenarios for 2020 and on December 31, 2024 . Guaranteed Unguaranteed Inception of lease Dr. Lease Receivable $121,185 Cr. Inventory 85,000 Cr. Unearned interest income 21,185 Dr. COGS 85,000 Cr. Sales Revenue 100,000 1 Lease receivable = 23,237 *5 + 5,000 2 Unearned interest income: = Lease receivable – FV of asset = 121,185 -100,000 = 21,185 Dr. Lease receivable $121,185 Cr. Inventory 85,000 Cr. Unearned interest income 21,185 Dr. COGS (85,000 – 3104) 81,896 Cr. Sales Revenue 96,895 First Dr. Cash 23,237 Dr. Cash 23,237

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Payment Cr. Lease receivable 23,237 Cr. Lease receivable 23,237 Dec. 31, 2020 Dr, unearned interest income Cr. Interest income Dr, unearned interest income Cr. Interest income Start the table with net investment: Net investment: 121,185- 21,185 = 100,000 Lease payment (-) Interest Reduction CV Jan 1 100,000 (net investment) Jan 1 23,237 0 23,982 76,018 Dec 31, 2020 23,982 7602 (76018 * 10%) 16,380 59,638 Prepare the journal entries under the guaranteed versus unguaranteed scenarios. Guaranteed Unguaranteed At end of lease term, Residual Value is 5,000 and asset Value is 3,000 Dr. Inventory 3000 Dr. Cash 2,000 Cr. Lease receivable 5,000 Dr. Inventory 3,000 Dr. Loss on Lease 2,000 Cr. Lease receivable 5,000 c. Explain how your answer to part (b) would differ if the situation included a $5,000 purchase option that was exercised at the end of the lease, rather than a guaranteed residual value Dr. Cash 5,000 Cr. Lease receivable 5,000 Question 6:

Referring to Question 4, assume that the lease agreement does not meet the capitalization criteria for the lessor, and is classified as an operating lease. Record all the needed entries by the lessor Jan 1, Dr. Cash 25,982 Cr. Rent revenue 25,982 *lease pmt and maintenance* Dec 31, Dr. Depreciation expense 20,100 Cr. Acc. Depreciation 20,100 The person/entity who owns the assets records depreciation.