tial Direct Costs and Related Issues On January 1, 2019, Amity Company leases a crane to Baltimore Company. The lease contains the following terms and provisions: • The lease is noncancelable and has a term of 10 years. • The lease does not contain a renewal or bargain purchase option. • The annual rentals are $3,870, payable at the beginning of each year. • Baltimore agrees to pay all executory costs directly to a third party. • The cost of the equipment to the lessor is $24,177.54. The fair value of the equipment is $25,700. • Amity incurs initial direct costs of $1,310.90. • The interest rate implicit in the lease is 12%. • Amity expects to collect all lease payments from Baltimore. • Amity estimates that the fair value at the end of the lease term will be $3,100 and that the economic life of the crane is 12 years. This value is not guaranteed by Baltimore. Required: 1. Next Level What are initial direct costs? Discuss the accounting treatment of these costs. Are they treated in the same manner for (a) an operating lease, (b) a sales-type lease, and (c) a direct financing lease? 2. From the lessor’s viewpoint, is the preceding lease a sales-type or direct financing lease? Give reasons to support your conclusion. 3. Prepare the journal entries for Amity for 2019.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

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Initial Direct Costs and Related Issues

On January 1, 2019, Amity Company leases a crane to Baltimore Company. The lease contains the following terms and provisions:

•	The lease is noncancelable and has a term of 10 years.
•	The lease does not contain a renewal or bargain purchase option.
•	The annual rentals are $3,870, payable at the beginning of each year.
•	Baltimore agrees to pay all executory costs directly to a third party.
•	The cost of the equipment to the lessor is $24,177.54. The fair value of the equipment is $25,700.
•	Amity incurs initial direct costs of $1,310.90.
•	The interest rate implicit in the lease is 12%.
•	Amity expects to collect all lease payments from Baltimore.
•	Amity estimates that the fair value at the end of the lease term will be $3,100 and that the economic life of the crane is 12 years. This value is not guaranteed by Baltimore.

Required:

1.	Next Level What are initial direct costs? Discuss the accounting treatment of these costs. Are they treated in the same manner for (a) an operating lease, (b) a sales-type lease, and (c) a direct financing lease?
2.	From the lessor’s viewpoint, is the preceding lease a sales-type or direct financing lease? Give reasons to support your conclusion.
3.	Prepare the journal entries for Amity for 2019.

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