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Chapter 21: Q21-6P_a. (page 1247)

Question: The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee.

Inception date

January 1, 2017

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

\(124,798

Residual value of equipment at end of lease term, guaranteed by the lessee

\)50,000

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at January 1, 2017

\(600,000

Lessor’s implicit rate

12%

Lessee’s incremental borrowing rate

12%

The lessee assumes responsibility for all executory costs, which are expected to amount to \)5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straightline depreciation method for all equipment.

Instructions

(a) Prepare an amortization schedule that would be suitable for the lessee for the lease term.

Short Answer

Expert verified

PV of minimum lease payments = $600,000.

Step by step solution

01

Meaning of lease asset amortization

The amortization of a leased asset is determined by the asset's historical cost, expected economic life, residual value, and the amortization method. Most finance leases are amortized with continuous payments over the term of the lease and are customized to meet the specific needs of the lessee.

02

Preparing an amortization schedule that would be suitable for the lessee for the lease term

VANCE COMPANY (Lessee)

Lease Amortization Schedule


Date

Annual Lease Payment Plus GRV

Interest (12%) in Liability

Reduction of Lease Liability

Lease Liability

1/1/17

$600,000

1/1/17

$124,798

$ 0

$124,798

475,202

1/1/18

124,798

57,024

67,774

407,428

1/1/19

124,798

48,891

75,907

331,521

1/1/20

124,798

39,783

85,015

246,506

1/1/21

124,798

29,581

95,217

151,289

1/1/22

124,798

18,155

106,643

44,646

12/31/22

50,000

5,354

44,646

0

Working Notes:

Note:Since the lease period (six years) exceeds 75% of the asset's remaining economic life, it is a capital lease to the lessee (six years). Furthermore, the present value of the minimum lease payments surpasses 90% of the asset's fair value.

The rounding error is $1

The rounding error is $3

Annual rental payment

$ 124,798

PV of an annuity-due of 1 for n = 6,i= 12%

4.60478

PV of periodic rental payments

$ 574,668

Guaranteed residual value

$ 50,000

PV for 1 for n=6,i=12%

.50663

PV of guaranteed residual value

$25,322

PV of periodic rental payments

$ 574,668

PV of guaranteed residual value

+ 25,332

PV of minimum lease payments

$ 600,000

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Most popular questions from this chapter

(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.

  1. The lease arrangement is for 10 years.
  2. The leased building cost \(4,500,000 and was purchased for cash on January 1, 2017.
  3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
  4. Lease payments are \)275,000 per year and are made at the end of the year.
  5. Property tax expense of \(85,000 and insurance expense of \)10,000 on the building were incurred by Nelson in the first year. Payment on these two items was made at the end of the year.
  6. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

(c) If Nelson paid $30,000 to a real estate broker on January 1, 2017, as a fee for finding the lessee, how much should Nelson Co. report as an expense for this item in 2017?

Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston’s specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is \)2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Instructions

(b) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Winston Industries.

(Lessee-Lessor Accounting for Residual Values) Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.

  1. The lease term is 10 years, noncancelable, and requires equal rental payments of \(30,300 due at the beginning of each year starting January 1, 2017.
  2. The equipment has a fair value and cost at the inception of the lease (January 1, 2017) of \)220,404, an estimated economic life of 10 years, and a residual value (which is guaranteed by Goring Dairy) of $20,000.
  3. The lease contains no renewable options, and the equipment reverts to King Finance Company upon termination of the lease.
  4. Goring Dairy’s incremental borrowing rate is 9% per year. The implicit rate is also 9%.
  5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.
  6. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(a) Evaluate the criteria for classification of the lease, and describe the nature of the lease. In general, discuss how the lessee and lessor should account for the lease transaction.

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

(2) Sales price.

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

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