Chapter 20, Problem 4P

Lessee Accounting Issues Timmer Company signs a lease agreement dated January 1, 2016, that provides for it to lease equipment from Landau Company beginning January 1, 2016. The lease terms, provisions, and related events are as follows:

• The lease is noncancelable and has a term of 5 years.
• The annual rentals are $83,222.92, payable at the end of each year, and provide Landau with a 12% annual rate of return on its net investment.
• Timmer agrees to pay all executory costs at the end of each year. In 2016, these were insurance, $3,760; property taxes, $5,440. In 2017: insurance, $3,100; property taxes, $5,330.
• There is no renewal or bargain purchase option.

Timmer estimates that the equipment has a fair value of $300,000, an economic life of 5 years, and a zero residual value. Timmer’s incremental borrowing rate is 16%, it knows the rate implicit in the lease, and it uses the straight-line method to record depreciation on similar equipment.

Required:

1. 1. Calculate the amount of the asset and liability of Timmer at the inception of the lease. (Round to the nearest dollar.)
2. 2. Prepare a table summarizing the lease payments and interest expense.
3. 3. Prepare journal entries on the books of Timmer for 2016 and 2017.
4. 4. Next Level Prepare a partial balance sheet in regard to the lease for Timmer for December 31, 2016. Use the change in present value approach to classify the capital lease obligation between current and noncurrent.
5. 5. If the lease term is 3 years with an annual payment of $120,000 and Timmer does not know the rate implicit in the lease, how would Timmer classify the lease under (a) U.S. GAAP and (b) IFRS?