Logout Open In App
Open In App
Warning: foreach() argument must be of type array|object, bool given in /var/www/html/web/app/themes/studypress-core-theme/template-parts/header/mobile-offcanvas.php on line 20

Chapter 21: 15Q_b (page 1239)

The residual value is the estimated fair value of the leased property at the end of the lease term.

(b) Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessor’s accounting for a direct-financing lease transaction?

Short Answer

Expert verified

The annual lease payment amount will be the same whether the value is guaranteed or non-guaranteed.

Step by step solution

01

Meaning of Fair value

The real worth of an item - a product, stock, or security – that's concurred upon by both the dealer and the buyer is referred to as fair value. The fair value applies to an item that's sold or exchanged within the market where it belongs or under standard circumstances – not to one that's being liquidated.

02

Explaining the significance

If the residual value is not guaranteed or guaranteed, the amount to be charged by the lessee is the same. As a result, whether the residual value is guaranteed or non-guaranteed, the amount of the annual lease payment established by the lessee is the same.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

(Lessee Computations and Entries, Capital Lease with Guaranteed Residual Value) Assume the same data as in P21-13 and that Chambers Medical Center has an incremental borrowing rate of 10%.

Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is \(411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be \)15,000. The hospital will pay rents of \(60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of \)250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.

Instructions

(c) Prepare all of the lessee’s journal entries for the first year.

Question: (Balance Sheet and Income Statement Disclosure—Lessee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017

\(300,383

Residual value at end of lease term

–0–

Lessor’s implicit rate

10%

Lessee’s incremental borrowing rate

10%

Annual lease payment due at the beginning of each year, beginning with October 1, 2017

\)62,700

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to \(5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This \)5,500 is not included in the rental payment of \(62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.

Date

Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?

Receivable

Balance of Lease Liability/Receivable

10/01/17

\)300,383

10/01/17

\(62,700

\)62,700

237,683

10/01/18

\(62,700

\)23,768

38,932

198,751

10/01/19

\(62,700

19,875

42,825

155,926

10/01/20

\)62,700

15,593

47,107

108,819

10/01/21

\(62,700

10,882

51,818

57,001

10/01/22

\)62,700

5,699*

57,001

0

\(376,200

\)75,817

\(300,383

*Rounding error is \)1.

Instructions

(a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement.


(2) What items and amounts will appear on the lessee’s balance sheet at September 30, 2018?

Question: (Lessee Entries and Balance Sheet Presentation, Capital Lease) On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of \(137,899 (including the executory costs of \)6,000) at the beginning of each year, starting January 1, 2017. The taxes, the insurance, and the maintenance, estimated at \(6,000 a year, are the obligations of the lessee. The leased equipment is to be capitalized at \)550,000. The asset is to be depreciated on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 12%, and the implicit rate in the lease is 10%, which is known by Cage. Title to the equipment transfers to Cage when the lease expires. The asset has an estimated useful life of 5 years and no residual value.

Instructions

(a) Explain the probable relationship of the $550,000 amount to the lease arrangement.

Indiana Jones Corporation enters into a 6-year lease of equipment on January 1, 2017, which requires 6 annual payments of \(40,000 each, beginning January 1, 2017. In addition, Indiana Jones guarantees the lessor a residual value of \)20,000 at lease-end. The equipment has a useful life of 6 years. Prepare Indiana Jones’ January 1, 2017, journal entries assuming an interest rate of 10%.

(Operating Lease vs. Capital Lease) You are auditing the December 31, 2017, financial statements of Hockney, Inc., manufacturer of novelties and party favors. During your inspection of the company garage, you discovered that a used automobile not listed in the equipment subsidiary ledger is parked there. You ask Stacy Reeder, plant manager, about the vehicle, and she tells you that the company did not list the automobile because the company was only leasing it. The lease agreement was entered into on January 1, 2017, with Crown New and Used Cars.

You decide to review the lease agreement to ensure that the lease should be afforded operating lease treatment, and you discover the following lease terms.

  1. Noncancelable term of 4 years.
  2. 2. Rental of \(3,240 per year (at the end of each year). (The present value at 8% per year is \)10,731.)
  3. 3. Estimated residual value after 4 years is \(1,100. (The present value at 8% per year is \)809.) Hockney guarantees the residual value of $1,100.
  4. 4. Estimated economic life of the automobile is 5 years.
  5. 5. Hockney’s incremental borrowing rate is 8% per year.

Instructions

You are a senior auditor writing a memo to your supervisor, the audit partner in charge of this audit, to discuss the above situation. Be sure to include (a) why you inspected the lease agreement, (b) what you determined about the lease, and (c) how you advised your client to account for this lease. Explain every journal entry that you believe is necessary to record this lease properly on the client’s books. (It is also necessary to include the fact that you communicated this information to your client.)
See all solutions

Recommended explanations on Business Studies Textbooks

Change Management

Read Explanation

Operational Management

Read Explanation

Human Resources

Read Explanation

Managers

Read Explanation

Influences On Business

Read Explanation

Organizational Behavior

Read Explanation
View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free