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Concept explainers
1.
Identify the type of lease involved for lessee and lessor and provide the reasons for such classification.
1.
![Check Mark](/static/check-mark.png)
Explanation of Solution
Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.
Capital leases: In capital lease all the ownership risks and responsibilities are transferred from the lessor to the lessee.
Direct Financing Lease: Under direct financing lease, the lessor considers the lease as a sale of the asset at fair value equal to the cost of the asset or its carrying value and records an accompanying receivable. Since there is no manufacture’s or dealer’s profit or loss, the lessor records the net amount at which the receivable must be equal to the cost of the asset or carrying value of the property.
Identify the type of lease involved for lessee and lessor:
Criteria | Met or not | Remarks |
1. Transfer of ownership at the end of lease | No | |
2. Bargain purchase option | No | |
3. Lease term is 75% or more | Not Known | |
4. Present value of lease payment is 90% or more of the fair value | Yes | 100% |
Recognition Criteria | ||
1. Collectivity assured | Yes | |
2. No Uncertainties | Yes |
Table (1)
Reason: From the above table, it is noted that, since one or more than one of the capitalization criteria and both the recognition criteria are met, the lease is a direct financing lease (absence of any dealer’s profit) for the Lessor Company and a capital lease for the Lessee Company.
Working note 1: Compute the present value of the lease payment.
2.
Prepare the
2.
![Check Mark](/static/check-mark.png)
Explanation of Solution
Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.
Rules of Debit and Credit: Following rules are followed for debiting and crediting different accounts while they occur in business transactions:
- Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and
stockholders’ equities . - Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.
Prepare the journal entries in the books of lessee and lessor for the years 2016 and 2017:
In the books of lessee:
Date | Accounts title and explanation | Post Ref. | Debit($) | Credit($) |
January 01, 2016 | Leased Equipment | 175,000.00 | ||
Capital Lease Obligation | 175,000.00 | |||
(To record the capital lease at inception) | ||||
January 01, 2016 | Capital Lease Obligation | 27,653.77 | ||
Cash | 27,653.77 | |||
(To record the capital lease payment) | ||||
During year | Insurance Expense: Capital Leases | 1,900.00 | ||
Property Tax Expense: Capital Leases | 1,300.00 | |||
Maintenance Expense: Capital Lease | 600.00 | |||
Cash | 3,800.00 | |||
(To record the payment of the executory costs ) | ||||
December 31,2016 | 17,500.00 | |||
| 17,500.00 | |||
(To record the depreciation expense) | ||||
December 31,2016 | Interest Expense | 17,681.55 | ||
Accrued Interest on Capital Lease Obligation | 17,681.55 | |||
(To record the interest expense) | ||||
January 01,2017 | Accrued Interest on Capital Lease Obligation | 17,681.55 | ||
Capital Lease Obligation | 9,972.22 | |||
Cash | 27,653.77 | |||
(To record the payment of accrued interest and capital lease) | ||||
During year | Insurance Expense: Capital Leases | 1,800.00 | ||
Property Tax Expense: Capital Leases | 1,200.00 | |||
Maintenance Expense: Capital Lease | 500.00 | |||
Cash | 3,500.00 | |||
(To record the payment of the executory costs ) | ||||
December 31,2017 | Depreciation Expense: Leased Equipment | 17,500.00 | ||
Accumulated Depreciation: Equipment | 17,500.00 | |||
(To record the depreciation expense) | ||||
December 31,2017 | Interest Expense | 16,484.88 | ||
Accrued Interest on CapitalLease Obligation | 16,484.88 | |||
(To record the interest expense) |
Table (2)
In the books of lessor:
Date | Accounts title and explanation | Post Ref. | Debit($) | Credit($) |
January 01,2016 | Equipment Leased to Others | 175,000.00 | ||
Cash | 175,000.00 | |||
(To record the payment of capital lease at inception) | ||||
January 01,2016 | Lease Receivable | 276,537.70 | ||
Equipment Leased to Others | 175,000.00 | |||
Unearned Interest: Leases | 101,537.70 | |||
(To record the lease receivable in a capital lease) | ||||
January 01,2016 | Cash | 27,653.77 | ||
Lease Receivable | 27,653.77 | |||
(To record the receipt lease payment) | ||||
December 31,2016 | Unearned Interest: Leases | 17,681.55 | ||
Interest Revenue: Leases | 17,681.55 | |||
(To recognize the interest revenue of the year) | ||||
January 01,2017 | Cash | 27,653.77 | ||
Lease Receivable | 27,653.77 | |||
(To record the receipt of lease payment of the year) | ||||
December 31,2017 | Unearned Interest: Leases | 16,484.88 | ||
Interest Revenue: Leases | 16,484.88 | |||
(To recognize the interest revenue of the year) |
Table (3)
Working note 2: Prepare the table regarding the lease payment received/required, interest revenue/expense and net investment.
Summary Table for 2016 and 2017 | |||
Lessee Company | |||
Lease payment required | Interest Expense | Balance of Lease Obligation | |
Lessor Company | |||
Date | Lease payment received | Interest Revenue | Net Investment |
January 01,2016 | $175,000.00 | ||
January 01,2016 | $27,653.77 | 0 | 147,346.23 |
December 31,2016 | $0.00 | $17,681.55 | 165,027.78 |
January 01,2017 | 27,653.77 | 0 | 137,374.01 |
December 31,2017 | 0 | 16,484.88 | 153,858.89 |
Table (4)
Notes to the above table:
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Cengagenowv2, 1 Term Printed Access Card For Wahlen/jones/pagach’s Intermediate Accounting: Reporting And Analysis, 2017 Update, 2nd
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