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Chapter 21: 16E_c (page 1244)

The following are four independent situations.

(c) On January 1, 2017, McKane Corp. sold an airplane with an estimated useful life of 10 years. At the same time, McKane leased back the plane for 10 years. The sales price of the airplane was 500,000,thecarryingamount379,000, and the annual rental $73,975.22. McKane Corp. intends to depreciate the leased asset using the sum-of-the-years’-digits depreciation method. Discuss how the gain on the sale should be reported at the end of 2017 in the financial statements.

Short Answer

Expert verified

Profit for the year is $22,000.

Step by step solution

01

Meaning of Depreciation

Depreciation is a decrease in the price of a physical commoditythat affects the monetary value of an asset due to a number of factors, such as wear and tear from extended use. The depreciation amount can be ascertained using the straight-line method and the diminishing balance method.

02

Explaining the gain on the sale should be reported at the end of 2017 in the financial statements

The profit on the sale of $121,000 must be deferred and amortized over the lease period. The delayed profit must be recorded identically since the leased asset is depreciated using the year-to-date method. As a result, the first year's profit will be $22,000 (10/55 $121,000).

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Most popular questions from this chapter

(Lessee Entries and Balance Sheet Presentation, Capital Lease) Ludwick Steel Company as lessee signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of 40,000aretobemadeatthebeginningofeachleaseyear(December31).Thetaxes,insurance,andthemaintenancecostsaretheobligationofthelessee.Theinterestrateusedbythelessorinsettingthepaymentscheduleis91, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Ludwick uses the straight-line method of depreciation on similar owned equipment.

Instructions

(b) Prepare the journal entry or entries, with explanations, that should be recorded on December 31, 2018, by Ludwick. (Prepare the lease amortization schedule for all five payments.)

(Lessor Entries; Direct-Financing Lease with Option to Purchase) Castle Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Jan Way Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement:

  1. Jan Way Company has the option to purchase the equipment for \(16,000 upon termination of the lease.
  2. The equipment has a cost and fair value of \)160,000 to Castle Leasing Company. The useful economic life is 2 years, with a salvage value of \(16,000.
  3. Jan Way Company is required to pay \)5,000 each year to the lessor for executory costs.
  4. Castle Leasing Company desires to earn a return of 10% on its investment.
  5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

  1. Prepare the journal entries on the books of Castle Leasing to reflect the payments received under the lease and to recognize income for the years 2017 and 2018.

(Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for 900,000byYoungCo.Themachineisexpectedtohavean8−yearlifewithnosalvagevalue.Itistobedepreciatedonastraight−linebasis.ThemachinewasleasedtoSt.LegerInc.onJanuary1,2017,atanannualrentalof210,000. Other relevant information is as follows.

  1. The lease term is for 3 years.
  2. Young Co. incurred maintenance and other executory costs of \(25,000 in 2017 related to this lease.
  3. The machine could have been sold by Young Co. for \)940,000 instead of leasing it.
  4. St. Leger is required to pay a rent security deposit of 35,000andtoprepaythelastmonth′srentof17,500.

Instructions

(a) How much should Young Co. report as income before income tax on this lease for 2017?

Rick Kleckner Corporation recorded a capital lease at 300,000onJanuary1,2017.Theinterestrateis1253,920 on January 1, 2017. The lease requires eight annual payments. The equipment has a useful life of 8 years with no salvage value. Prepare Kleckner Corporation’s December 31, 2017, adjusting entries.

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 5,500peryearandaretobepaideachOctober1,beginningOctober1,2017.(This5,500 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.

(b) Assuming the lessee’s accounting period ends on December 31, answer the following questions with respect to this lease agreement.

(4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2018?
See all solutions

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