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Chapter 21: Q4CA-2_b (page 1252)

(Comparison of Different Types of Accounting by Lessee and Lessor)

Part 2: Sales-type leases and direct-financing leases are two of the classifications of leases described in FASB pronouncements from the standpoint of the lessor.

Instructions

Compare and contrast a sales-type lease with a direct-financing lease as follows.

(b) Recognition of interest revenue.

Do not discuss the criteria for distinguishing between the leases described above and operating leases.

Short Answer

Expert verified

For both a sale-type lease and a direct financing lease, interest revenue is recognized over the term of the lease.

Step by step solution

01

Meaning of Interest Revenue

The money received by trade from whatever investments it makes or debt it keeps is referred to as interest revenue. Deducting present value from rental payments yields interest revenue. The amount of the difference is multiplied by the implicit interest rate.

02

Comparing and contrasting a sale-type lease with recognition of interest revenue.

The interest income is recognized during the lease term using the effective interest technique to provide a consistent periodic rate of return on the lease receivable for both a sales-type lease and a direct financing lease. Other techniques of income recognition, on the other hand, may be utilized if the results produced are not significantly different from those obtained using the interesting approach.

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Most popular questions from this chapter

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

  1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
  2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
  3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
  4. Cole Company assumes direct responsibility for all executory costs.
  5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
  6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(b) Prepare an amortization schedule that would be suitable for the lessor for the lease term.

Assume that IBM leased equipment that was carried at a cost of \(150,000 to Sharon Swander Company. The term of the lease is 6 years beginning January 1, 2017, with equal rental payments of \)30,044 at the beginning of each year. All executory costs are paid by Swander directly to third parties. The fair value of the equipment at the inception of the lease is $150,000. The equipment has a useful life of 6 years with no salvage value. The lease has an implicit interest rate of 8%, no bargain-purchase option, and no transfer of title. Collectibility is reasonably assured with no additional cost to be incurred by IBM. Prepare IBM’s January 1, 2017, journal entries at the inception of the lease.

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

(c) Prepare the journal entry to record depreciation of the leased asset for the year 2017.

(Lessor Entries; Sales-Type Lease) Crosley Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, 2017. The lease is for an 8-year period and requires equal annual payments of \(35,013 at the beginning of each year. The first payment is received on January 1, 2017. Crosley had purchased the machine during 2016 for \)160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by Crosley. Crosley set the annual rental to ensure an 11% rate of return. The machine has an economic life of 10 years with no residual value and reverts to Crosley at the termination of the lease.

Instructions

(b) Prepare all necessary journal entries for Crosley for 2017.

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

(d) Prepare the journal entry to record the interest expense for the year 2017.
See all solutions

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