Concept explainers
Sales-Type Lease with Guaranteed Residual Value Calder Company, the lessor, enters into a lease with Darwin Company, the lessee, to provide heavy equipment beginning January 1, 2017. The lease is appropriately classified as a sales-type lease. The lease terms, provisions, and related events are as follows:
- The lease is noncancelable, has a term of 8 years, and has no renewal or bargain purchase option.
- The annual rentals are $65,000, payable at the end of each year.
- The interest rate implicit in the lease is 15%.
- Darwin agrees to pay all executory costs directly to a third party.
- The cost of the equipment is $280,000. The fair value of the equipment to Calder is $308,021.03.
- Calder incurs no material initial direct costs.
- Calder expects that it will be able to collect all lease payments.
- Calder estimates that the fair value at the end of the lease term will be $50,000 and that the economic life the equipment is 9 years. This residual value is guaranteed by Darwin.
The following present value factors are relevant:
- PV of an ordinary annuity n = 8, i = 15% = 4.487322
- PV n = 8, i = 15% = 0.326902
- PV n = 1, i = 15% = 0.869565
Required:
- 1. Determine the proper classification of the lease.
- 2. Prepare a table summarizing the lease receipts and interest income earned by Calder for this lease.
- 3. Prepare
journal entries for Calder for the years 2019, 2020, and 2021. - 4. Next Level Prepare partial
balance sheets for December 31, 2019, and December 31, 2020, showing how the accounts should be reported. Use the present value of next year’s payment approach to classify the lease receivable as current and noncurrent. - 5. Next Level Prepare partial balance sheets for December 31, 2019, and December 31, 2020, showing how the accounts should be reported. Use the change in present value approach to classify the lease receivable as current and noncurrent.
1.
Identify the proper classification of the lease.
Explanation of Solution
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.
The reasons for classifying the lease as direct financing lease from the criteria table as presented below:
Capitalization Criteria | Met or not | Remarks |
1.Transfer of ownership at the end of lease | No | |
2.Bargain purchase option | No | |
3.Lease term is for major part of its economic life | Yes | 89% |
4.Present value of lease payments is substantially all of the fair value | Yes | PV is 100% of the fair value of the equipment |
5. Specializes nature of the asset | ||
Additional criteria (For lessor) | ||
1. Present value of lease payments and any guaranteed residual value equals or exceeds substantially all of the fair value | Yes | |
2. Probable that the lessor will collect the lease payments | Yes |
Table (2)
From the above table, it is noted that the lease is a sales type lease for Company C as more than one capitalization criteria is met and both of the recognition criteria also met according to the terms of the lease agreement.
Working Note 1: Compute the present value of minimum lease payment:
2.
Prepare a table summarizing the lease receipts and interest revenue earned by the lessor for the direct financing lease.
Explanation of Solution
Prepare a table summarizing the lease receipts and interest revenue earned by the lessor for the direct financing lease:
Date | Lease payment received | Interest revenue at 15% | Decrease in lease receivable | Lease receivable |
(1) | (2) | (3) | (4) | (5) |
January 1,2019 | $ 308,021.03 | |||
December31,2019 | $65,000.00 | $ 46,203.15 | $ 18,796.85 | $ 289,224.18 |
December31,2020 | $65,000.00 | $ 43,383.63 | $ 21,616.37 | $ 267,607.82 |
December31,2021 | $65,000.00 | $ 40,141.17 | $ 24,858.83 | $ 242,748.99 |
December31,2022 | $65,000.00 | $ 36,412.35 | $ 28,587.65 | $ 214,161.34 |
December31,2023 | $65,000.00 | $ 32,124.20 | $ 32,875.80 | $ 181,285.54 |
December31,2024 | $65,000.00 | $ 27,192.83 | $ 37,807.17 | $ 143,478.37 |
December31,2025 | $65,000.00 | $ 21,521.75 | $ 43,478.25 | $ 100,000.13 |
December31,2026 | $65,000.00 | $ 14,999.87 | $ 50,000.13 | $ 50,000.00 |
Table (1)
Notes to the above table:
3.
Prepare the journal entries for Company C for the years 2019, 2020, and 2021.
Explanation of Solution
Prepare the journal entries for Company C for the years 2019, 2020, and 2021:
Date | Accounts title and explanation | Post Ref. | Debit($) | Credit($) |
January 1,2019 | Equipment Leased to Others | 308,021.03 | ||
Cash | 308,021.03 | |||
(To record the payment of capital lease at inception) | ||||
January 1,2019 | Cost of goods sold | $280,000 | ||
Equipment leased to others | $280,000 | |||
(To record the cost of the leased equipment) | ||||
December 31,2019 | Cash | $65,000.00 | ||
Lease Receivable | $18,796.85 | |||
Interest Revenue: Leases | $46,203.15 | |||
(To recognize the interest revenue of the year) | ||||
December 31,2020 | Cash | $65,000.00 | ||
Lease Receivable | $21,616.37 | |||
Interest Revenue: Leases | $43,383.63 | |||
(To recognize the interest revenue of the year) | ||||
December 31,2021 | Cash | $65,000 | ||
Lease Receivable | $24,858.83 | |||
Interest Revenue: Leases | $40,141.17 | |||
(To recognize the interest revenue of the year) |
Table (3)
4.
Prepare a partial balance sheet for December 31, 2019 and December 31, 2020 showing the reported accounts in it.
Explanation of Solution
Balance Sheet: Balance Sheet is one of the financial statements which summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.
Here using the present value of next year’s payment approach to classify the lease receivable as current and non-current.
Prepare a partial balance sheet for December 31, 2019 and December 31, 2020 showing the reported accounts in it:
Company C | ||
Balance Sheet(Partial) | ||
As on December 31 | ||
Particulars | 2019 | 2020 |
Assets | ||
Current Assets: | ||
Net Investment in Direct Financing Leases | $56,521.73 | $56,521.73 |
Non-Current Assets: | ||
Net Investment in Direct Financing Leases | $211,086.08 | $232,702.45 |
Liabilities | ||
Current liabilities: | ||
Non-Current liabilities: | ||
Table (4)
Notes for the above table:
5.
Prepare a partial balance sheet for December 31, 2016 and December 31, 2017 showing the reported accounts in it.
Explanation of Solution
Here using the present value approach to classify the lease receivable as current and non-current.
Prepare a partial balance sheet for December 31, 2016 and December 31, 2017 showing the reported accounts in it:
Company C | ||
Balance Sheet(Partial) | ||
As on December 31 | ||
Particulars | 2016 | 2017 |
Assets | ||
Current Assets: | ||
Net Investment in Direct Financing Leases | $24,858.83 | $21,616.37 |
Non-Current Assets: | ||
Net Investment in Direct Financing Leases | $242,748.99 | $267,607.82 |
Liabilities | ||
Current liabilities: | ||
Non-Current liabilities: | ||
Table (4)
Notes for the above table:
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Chapter 20 Solutions
Intermediate Accounting: Reporting And Analysis
- Lessee Accounting with Payments Made at Beginning of Year Adden Company signs a lease agreement dated January 1, 2019, that provides for it to lease non-specialized heavy equipment from Scott Rental Company beginning January 1, 2019. The lease terms, provisions, and related events are as follows: 1. The lease term is 4 years. The lease is noncancelable and requires annual rental payments of 20,000 to be paid in advance at the beginning of each year. 2. The cost, and also fair value, of the heavy equipment to Scott at the inception of the lease is 68,036.62. The equipment has an estimated life of 4 years and has a zero estimated residual value at the end of this time. 3. Adden agrees to pay all executory costs directly to a third party. 4. The lease contains no renewal or bargain purchase options. 5. Scotts interest rate implicit in the lease is 12%. Adden is aware of this rate, which is equal to its borrowing rate. 6. Adden uses the straight-line method to record depreciation on similar equipment. 7. Executory costs paid at the end of the year by Adden are: Required: 1. Next Level Determine what type of lease this is for Adden. 2. Prepare a table summarizing the lease payments and interest expense for Adden. 3. Prepare journal entries for Adden for the years 2019 and 2020.arrow_forwardComprehensive Landlord Company and Tenant Company enter into a noncancelable, direct financing lease on January 1, 2019, for nonspecialized equipment that cost the Landlord 280,000 (useful life is 6 years with no residual value). The fair value of the equipment is 300,000. The interest rate implicit in the lease is 14%. The 6-year lease requires 6 equal annual amounts payable each January 1, beginning with January 1, 2019. Tenant pays all executory costs directly to a third party on December 1 of each year. The equipment reverts to the lessor at the termination of the lease. Assume that there are no initial direct costs. Landlord expects to collect all rental payments. Required: 1. Next Level (a) Show how landlord should compute the annual rental amounts, (b) Discuss how the Tenant Company should compute the present value of the lease payments. What additional information would be required to make this computation? 2. Next Level Prepare a table summarizing the lease and interest receipts that would be suitable for Landlord. Under what conditions would this table be suitable for Tenant? 3. Assuming that the table prepared in Requirement 2 is suitable for both the lessee and the lessor, prepare the journal entries for both firms for the years 2019 and 2020. Use the straight-line depreciation method for the leased equipment. The executory costs paid by the lessee are in 2019: insurance, 700 and property taxes, 800; in 2020: insurance, 600 and property taxes, 750. 4. Next Level Show the items and amounts that would be reported on the comparative 2019 and 2020 income statements and ending balance sheets for both the lessor and the lessee, using the change in present value approach.arrow_forwardLessee Accounting Issues Timmer Company signs a lease agreement dated January 1, 2019, that provides for it to lease equipment from Landau Company beginning January 1, 2019. 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 directly to a third party on December 1 of each year. In 2019, these were insurance, 3,760; property taxes, 5,440. In 2020: 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. Timmers incremental borrowing rate is 16%, it knows the rate implicit in the lease, and it uses the straightline method to record depreciation on similar equipment. Required: 1. Calculate the amount of the asset and liability of Timmer at the inception of the lease. (Round to the nearest dollar.) 2. Prepare a table summarizing the lease payments and interest expense. 3. Prepare journal entries on the books of Timmer for 2019 and 2020. 4. Next Level Prepare a partial balance sheet in regard to the lease for Timmer for December 31, 2019. Use the present value of next years payment approach to classify the finance lease obligation between current and noncurrent. 5. Next Level Prepare a partial balance sheet in regard to the lease for Timmer for December 31, 2019. Use the change in present value approach to classify the finance lease obligation between current and noncurrent.arrow_forward
- Determining Type of Lease and Subsequent Accounting On January 1, 2019, Ballieu Company leases specialty equipment with an economic life of 8 years to Anderson Company. The lease contains the following terms and provisions: The lease is noncancelable and has a term of 8 years. The annual rentals arc 35,000, payable at the beginning of each year. The interest rate implicit in the lease is 14%. Anderson agrees to pay all executory costs directly to a third party and is given an option to buy the equipment for 1 at the end of the lease term, December 31, 2026. The cost of the equipment to the lessee is 150,000, and the fair value is approximately 185,100. Ballieu incurs no material initial direct costs. It is probable that Ballieu will collect the lease payments. Ballieu estimates that the fair value is expected to be significantly greater than 1 at the end of the lease term. Ballieu calculates that the present value on January 1, 2019, of 8 annual payments in advance of 35,000 discounted at 14% is 185,090.68 (the 1 purchase option is ignored as immaterial). Required: 1. Next Level Identify the classification of the lease transaction from Ballices point of view. Give the reasons for your classification. 2. Prepare all the journal entries tor Ballieu for the years 2019 and 2020. 3. Discuss the disclosure requirements for the lease transaction in Ballices notes to the financial statements.arrow_forwardLessee Accounting Issues Sax Company signs a lease agreement dated January 1, 2019, that provides for it to lease computers from Appleton Company beginning January 1, 2019. The lease terms, provisions, and related events are as follows: 1. The lease term is 5 years. The lease is noncancelable and requires equal rental payments to be made at the end of each year. The computers are not specialized for Sax. 2. The computers have an estimated life of 5 years, a fair value of 300,000, and a zero estimated residual value. 3. Sax agrees to pay all executory costs directly to a third party. 4. The lease contains no renewal or bargain purchase options. 5. The annual payment is set by Appleton at 83,222.92 to earn a rate of return of 12% on its net investment. Sax is aware of this rate. Saxs incremental borrowing rate is 10%. 6. Sax uses the straight-line method to record depreciation on similar equipment. Required: 1. Next Level Examine and evaluate each capitalization criteria and determine what type of lease this is for Sax. 2. Calculate the amount of the asset and liability of Sax at the inception of the lease (round to the nearest dollar). 3. Prepare a table summarizing the lease payments and interest expense. 4. Prepare journal entries for Sax for the years 2019 and 2020.arrow_forwardUse the information in RE20-3. Prepare the journal entries that Garvey Company would make in the first year of the lease assuming the lease is classified as a finance lease. However, assume that Garvey is now required to make the 65,949.37 payments on January 1 each year and that the fair value at the lease inception is now 275,000 (65,949:37 4:169865).arrow_forward
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- Intermediate Accounting: Reporting And AnalysisAccountingISBN:9781337788281Author:James M. Wahlen, Jefferson P. Jones, Donald PagachPublisher:Cengage Learning