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Chapter 21: 18Q (page 1239)

What are “initial direct costs” and how are they accounted for?

Short Answer

Expert verified

Initial direct costs are additional costs resulting from the lessee arranging, completing, and initially managing the leasing transaction.

Step by step solution

01

Meaning of initial direct cost

Internal direct costs are specifically related to the activities conducted by the lessor on a particular lease. Internal indirect costs should not be included within the unique direct costs. Such costs are caused as a result of the lessor's activities, such as promoting, overhauling current leases, and making and observing credit approaches.

02

Explaining the accountability of initial direct costs

In the case of operational leases, the lessor should defer early direct expenses and allocate them over the lease period in proportion to rent revenue recognition. The lessor deducts the initial direct costs in the year of incurrence in a sales-type lease arrangement (i.e., the year in which profit on the sale is recognized).

Initial direct expenses should be included in the net lease investment and amortized throughout the lease's duration as a yield adjustment in a direct-financing lease.

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Most popular questions from this chapter

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 $411, 324, a n d i t s g u a r a n t e e d r e s i d u a l v a l u e a t t h e e n d o f t h e n o n c a n c e l a b l e l e a s e t e r m i s e s t i m a t e d t o b e$ 15,000. The hospital will pay rents of $60, 000 a t t h e b e g i n n i n g o f e a c h y e a r a n d a l l m a i n t e n a n c e, i n s u r a n c e, a n d t a x e s . A m i r a n t e I n c . i n c u r r e d c o s t s o f$ 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

(b) Prepare a 10-year lease amortization schedule.

(Lessee Accounting and Reporting) On January 1, 2017, Evans Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Evans by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2017, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Instructions

(d) How should Evans report the lease transaction on its December 31, 2017, balance sheet?

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 $137, 899 (i n c l u d i n g t h e e x e c u t o r y c o s t s o f$ 6,000) at the beginning of each year, starting January 1, 2017. The taxes, the insurance, and the maintenance, estimated at $6, 000 a y e a r, a r e t h e o b l i g a t i o n s o f t h e l e s s e e . T h e l e a s e d e q u i p m e n t i s t o b e c a p i t a l i z e d a t$ 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

(f) What amounts will appear on the lessee’s December 31, 2017, balance sheet relative to the lease contract?

(Operating Lease for Lessee and Lessor) On February 20, 2017, Barbara Brent Inc. purchased a machine for $1, 500, 000 f o r t h e p u r p o s e o f l e a s i n g i t . T h e m a c h i n e i s e x p e c t e d t o h a v e a 10 - y e a r l i f e, n o r e s i d u a l v a l u e, a n d w i l l b e d e p r e c i a t e d o n t h e s t r a i g h t - l i n e b a s i s . T h e m a c h i n e w a s l e a s e d t o R u d y C o m p a n y o n M a r c h 1, 2017, f o r a 4 - y e a r p e r i o d a t a m o n t h l y r e n t a l o f$ 19,500. There is no provision for the renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. Brent paid $30,000 of commissions associated with negotiating the lease in February 2017.

Instructions

(b) What income or loss before income taxes should Brent record as a result of the facts above for the year ended December 31, 2017? (Hint: Amortize commissions over the life of the lease.)

Geiberger Corporation manufactures replicators. On January 1, 2017, it leased to Althaus Company a replicator that had cost $110, 000 t o m a n u f a c t u r e . T h e l e a s e a g r e e m e n t c o v e r s t h e 5 - y e a r u s e f u l l i f e o f t h e r e p l i c a t o r a n d r e q u i r e s 5 e q u a l a n n u a l r e n t a l s o f$ 40,800 payable each January 1, beginning January 1, 2017. An interest rate of 12% is implicit in the lease agreement. Collectibility of the rentals is reasonably assured, and there are no important uncertainties concerning costs. Prepare Geiberger’s January 1, 2017, journal entries.

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