Chapter 21 Lease Answer Problems

CHAPTER 21 ACCOUNTING FOR LEASES CONTENT ANALYSIS OF EXERCISES AND PROBLEMS measure wave (minutes) 5-10 Number E21-1 Content Operating learn. (Easy) annual lead payments, no renewable pickax clause, executory costs. Lessees ledger entries to record agreement, payments, spendings. chapiter pick out. (Mode charge per unit) deliberateness of rental payments made at end of yr. Table summarizing have payments, interest expense. Journal entries. IFRS differences. crown shoot. (Moderate) hires made at beginning of year. Table summarizing acquire payments, interest expense. Journal entries. treat Financing bring. (Moderate) Calculation of rental receipts, made at end of year. Table summarizing rental receipts, interest gross. Journal entries. Direct Financing have. (Easy) Journal entries to record contract, first rental receipt. Direct Financing postulate / cracking select. (Moderate) Table summarizing lock and interest payments. Journal entries for less(prenominal)or and lessee. Sales-Type term of a contract. (Moderate) Payments made at end of year. Calculation of selling price ( join prise). Table summarizing choose receipts, interest revenue. Journal entries. Sales-Type Lease. Moderate) Payments made at beginning of year. Calculation of selling price ( decent quantify). Table summarizing hire receipts, interest revenue. Journal entries. Sales-Type Lease / Capital Lease. (Moderate) computer science of deal payments. Journal entries for lessor and lessee. Operating Lease / Sales-Type Lease. (Moderate) Accounted for as operating, should have been trades- caseful. Computation of effect on net income. Operating Lease. (Easy) Computation of income derived from exact by lessor, make out of rent expense for lessee. E21-2 15-25 E21-3 10-15 E21-4 10-15 E21-5 E21-6 5-10 10-15E21-7 10-15 E21-8 10-15 E21-9 E21-10 10-15 10-20 E21-11 10-15 21-1 Number E21-12 Content Determining Type of Lease. (Moderate) Title passes at leaseend, collectibility reas onably assured, no uncertainties environ costs to be incurred. Table summarizing receipts, revenue. Lessors journal entries. Guaranteed and Unguaranteed Residual Values. (Moderate) Calculate residual set. Determine classification of the lease depending on the type of residual appreciate. (Appendix). Sales-Leaseback. (Easy) Calculation of lease payments. Lessors journal entries to record sale and agreement.Description of how to treat the gain by the lessee. Determining Type of Lease. (Moderate) No plenty barter for option, no agreement to transfer self-control at lease-end, no uncertainties surrounding costs to be incurred. Journal entries for lessee and lessor. Guaranteed residual regard as. Determining Type of Lease. (Moderate) Lessors viewpoint. Option to buy, collectibility reasonably assured, no uncertainties surrounding costs. Journal entries, disclosure requirements. Capital Lease. (Moderate) Calculation of rental payments. Table summarizing lease payments, interest exp ense.Journal entries, start outial equilibrate sheet. IFRS differences. Direct Financing Lease. (Challenging) Table summarizing lease receipts, interest revenue. rendering of lease classification. Journal entries. Partial balance sheets. Comprehensive Direct Financing and Capital Lease. (Challenging) Computation of rental amounts. Table summarizing lease and interest receipts. Analysis of lessees lease classification. Journal entries for lessor and lessee. Comparative monetary pedagogy presentation. Direct Financing Lease. (Moderate) Unguaranteed residual encourage. Computation of rental amounts.Table summarizing lease and interest receipts. Journal entries. Sales-Type Lease. (Challenging) Calculation of implied selling price. Table summarizing lease receipts, interest revenue. Explanation of lease classification. Journal entries, partial balance sheet. Various Lease Issues. (Challenging) Journal entries for lessee and lessor to record all lease doings. Various Lease Issues. (Challenging) Computation of annual rentals if collectible at beginning of year, at end of year. Table. Journal entries for lessee and lessor. Partial balance sheet disclosures. 21-2Time Range (minutes) 15-20 E21-13 15-25 E21-14 15-20 P21-1 30-40 P21-2 25-35 P21-3 30-50 P21-4 35-50 P21-5 45-60 P21-6 30-40 P21-7 30-45 P21-8 P21-9 30-45 45-60 Number P21-10 Content Initial Direct make ups. (Moderate) Analysis for motley lease classifications. last of lessors lease classification. Discussion of lessors journal entries. Various Lease Issues. (Challenging) motley of lease for lessee, for lessor. Option to buy, collectibility reasonably assured, no uncertainties. Lessor journal entries. Accounting for a transfer in residual honor. Accounting for Leases. Challenging) Journal entries to record the lease for both the lessee and lessor. (AICPA adapted). Lessors Income Statement. (Challenging) Prepa symmetryn of lessors income statement, including sales-type and operating lease as well a s long-term construction contracts. (Appendix). Determining Types of Leases. (Moderate) For lessee, for lessor. Lease of land. No bargain purchase option, collectibility reasonably assured, no uncertainties surrounding costs. (Appendix). Sales-Leaseback. (Moderate) Classification of lease by lessee. Journal entries for both lessee and lessor. Time Range (minutes) 20-30P21-11 30-45 P21-12 P21-13 30-45 50-60 P21-14 10-20 P21-15 20-30 ANSWERS TO QUESTIONS Q21-1 Q21-2 GAAP provides a common set of criteria for determining the classification of leases by both the lessee and the lessor. The advantages of leasing for the lessee take 1. Financing benefits a. b. c. The lease provides 100% financial backing so that the lessee acquires the asset without having to make a down payment. The lease contract may contain fewer restrictive provisions for funding. The leasing arrangement creates a claim that is against exactly the leased equipment and non against all assets. 2.Risk benefit The le ase may reduce the risk of obsolescence for the lessee. 3. take account benefit For income tax purposes, the lessee, through deduction of the lease payment, crumb write off the full cost of an asset. 4. Financial reporting benefit For operating leases, the lease does not add an asset or a liability to the lessees balance sheet. 5. Billing benefit For certain contract-type work, leasing may permit higher charges because interest on borrowed money to purchase assets is not usually allowed as a contract charge, whereas the interest element contained in the rental payments is allowed as a contract charge. 1-3 Q21-3 By structuring the terms of the lease so that it qualifies as an operating lease, the lessee avoids having to include the asset and the liability in the balance sheet. Exclusion of these items creates much favorable financial ratios, such as rate of return on investment, the current ratio, and the ratio of debt to equity. This, in turn, may increase the borrowing capacit y of the lessee. The lessee is practicing off balance sheet financing. A bully lease, on the other hand, would appear in the financial statements and affect financial ratios.It may impede lessee borrowing efforts. a. A lease is an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets), usually for a stated period of time. b. A sales-type lease for the lessor is a lease that meets any one of the tug A criteria and both of the Column B criteria in shew 20-2, and results in a manufacturers or dealers gelt. c. A direct financing lease for the lessor is a lease that meets any one of the Column A criteria and both of the Column B criteria, and does not result in a manufacturers or dealers profit. d.A sale-leaseback transaction is a lease transaction in which the owner of an asset sells it, and then directly leases it back from the buyer. e. An operating lease for the lessee is a lease that meets none of the Column A criteria. For the le ssor, it is a lease that meets none of the Column A criteria, and fails at least one of the Column B criteria. f. A leveraged lease is a three-party lease in which one party (the equity participant) buys or manufactures an asset and leases it to some other party (the asset user), with a tertiary party (the debt participant) providing nonrecourse financing for the transaction.Q21-4 Q21-5 a. Inception of lease is the era of the lease agreement or, if the leased property is being constructed, the date that the title passes to the lessor. b. Bargain purchase option is a provision allowing the lessee to purchase the leased property at the end of the life of the lease at a price so favorable that the exercise of the option appears, at the stemma of the lease, to be reasonably assured. c. Unguaranteed residual determine is the portion of the estimated residual c atomic number 18 for of the leased property that is not guaranteed by the lessee or by a third party unrelated to the lesso r. . Implicit interest rate is the interest (discount) rate that, when applied on a present think of basis to the sum of the press down limit lease payments and any insecure residual grade accruing to the lessor, causes the resulting present value to be equal to the net investment of the leased property to the lessor. 21-4 Q21-5 (continued) e. Initial direct costs be costs incurred by the lessor to originate a lease that (1) result directly from acquiring that lease and (2) would not have been incurred had that leasing transaction not occurred.They also include costs directly related to specified activities performed by the lessor for that lease, such as evaluating the lessees financial condition, negotiating lease terms, preparing and processing lease documents, and closing the transaction. Q21-6 If in that respect is a bargain purchase option, the components of the marginal lease payments ar (1) the stripped periodic rental payment unavoidable by the lease over the leas e term, and (2) the payment required by the bargain purchase option.Otherwise, they include (1) the lower limit periodic rental payments plus (2) any guarantee by the lessee of the residual value, and (3) any payments upon failure to renew or extend the lease. The criteria for a capital letter lease are 1. Transfer of possession at end of lease 2. Bargain purchase option 3. Lease term is 75% or much of the estimated stinting life of the asset 4. Present value of stripped lease payments is 90% or more of fair value of the leased property to the lessor One (or more) of these criteria must(prenominal) be met for the lessee to crystallize a lease as a capital lease.Q21-8 Under an operating lease, the lessee records each rental payment as rent expense no amount is capitalized. The lessor records each rental receipt as rent revenue. The leased asset is retained on the lessors books and is depreciated by the lessor. Under a capital lease, the lessee records the present value of the mi nimum lease payments as both an asset and a liability. The lessee recognizes a portion of each payment as interest expense to produce a constant rate of interest on the book value at the beginning of the period, and recognizes the remainder of the payment as a decline of the lease liability.The lessee depreciates the asset over the term of the lease, unless there is a bargain purchase option or transfer of ownership at the end of the lease, in which case the depreciation period is the stinting life of the asset. The two additional criteria for a sales-type lease are 1. Collectibility of the minimum lease payments is reasonably assured. 2. No pregnant uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease. In addition, the lease must result in a manufacturers or dealers profit or vent.Q21-7 Q21-9 Q21-10 21-5 Q21-11 The basic difference in accounting for a sales-type lease is that the carrying value of the asset is charged to co st of asset leased (expense), and the present value of the minimum lease payments is recorded as the amount of the sale. In a direct financing lease, no sales or expense is recognized. Instead, the asset is outback(a) from the books and the difference between its carrying value and the undiscounted minimum lease payments is recorded as unearned interest revenue.The net investment in a sales type lease is accounted for in a similar manner to that for a direct financing lease. The FASB states that the interest revenue from a lease is recognized so as to yield a constant return on net investment. Compound interest techniques can be used to compute this return if the undermentioned are known (a) the amount of the lease payment, (b) the cost or fair value of the lease, and (c) the number of periods of the lease. Multiplying the interest rate by the amount of the net investment at the beginning of the year results in a constant return on investment.Q21-12 Q21-13 Q21-14 Owens union reco rds the lease as a capital lease due to the bargain purchase option, and depreciates the asset over its estimated sparing life. The original lease was a capital lease and McFarland club is relieved of its obligation. McFarland removes the equipment from its books, and recognizes the gain when the new lease transaction takes place, that is, during the current year. a. Lessees disclosure 1. For all leases, a general description of the leasing arrangement 2.For operating leases having lease terms in excess of one year (a) prox minimum rental payments required as of the date of the latest balance sheet presented, for each of the 5 succeeding fiscal years and in make out The total of minimum rentals to be authentic in the future under noncancellable subleases Q21-15 (b) 3. For all operating leases, rental expense for each period 4. For capital leases (a) (b) The hoggish amount of assets recorded under capital leases by major classes according to nature or function Future minimum l ease payments for each of the 5 succeeding fiscal years and in total 21-6 Q21-15 (continued) a. 4. continued) (c) (d) The total of minimum sublease rentals to be sure in the future under noncancellable subleases Assets, accumulated depreciation, depreciation expense, and liabilities b. Lessors disclosure 1. A general description of all leasing arrangements 2. For operating leases (a) The cost and carrying amount, if different, of property on lease or held for leasing by major classes of property, and the amount of the total accumulated depreciation Minimum future rentals on noncancellable leases for each of the 5 succeeding fiscal years and in total Total contingent rentals include in income for each period b) (c) 3. For direct financing and sales-type leases (a) The components of the net investment in direct financing and sales-type leases including (1) (2) (3) (4) (b) (c) Q21-16 Q21-17 The future minimum lease payments to be standard Including any profit thereon The unguaranteed residual values accruing to the benefit of the lessor For direct financing leases only, initial direct costs unearned income Future minimum lease payments to be received for each of the 5 succeeding fiscal years Total contingent rentals included in income for each periodIFRS classify leases as either finance leases or operating leases. A finance lease is equivalent to a capital lease under U. S. GAAP. In general, IFRS provide a series of indicators that, individually or in combination, normally lead a lease to be sort out as a finance lease. U. S. GAAP contains a series of four criteria which, if any one is met, will result in the classification of a lease as a capital lease. While these indicators and criteria are similar, the IFRS indicators are less detailed and require more judgment in classifying leases. Specifically, both IFRS and U.S. GAAP treat leases that transfer title from the lessor to the lessee and leases that contain bargain purchase options as finance (capital) lea ses. However, if an asset is leased for the major part of an assets economic life, IFRS consider this an indicator of a finance lease. IFRS do not define what is meant by comfortably all of the assets fair value while U. S. GAAP sets a 90% threshold. 21-7 Q21-18 The primary accounting case in accounting for a sales-leaseback transaction from the seller-lessees viewpoint is the recognition of a profit or a loss on the sale.Any profit or loss is deferred and amortized in proportion to the amortization of the leased asset, if a capital lease, or in proportion to the rental payments, if an operating lease. If the fair value of the property is less than its undepreciated cost at the time of the transaction, a loss is recognized immediately on the difference between the undepreciated cost and the fair value. The fact that there are three or four parties (equity participant, asset user, debt participant, and also a manufacturer if the equity participant does not make the product) disting uishes a leveraged lease from other leases.For the lessee there are no new accounting issues. The lessee classifies and accounts for the lease as for a nonleveraged lease. Q21-19 ANSWERS TO MULTIPLE CHOICE 1. 2. a b 3. 4. d b 5. 6. a c 7. 8. b c 9. 10. a d 21-8 SOLUTIONS TO REVIEW EXERCISES RE21-1 1. 2. 3. 4. Classification Criteria Transfer of ownership at end of lease Bargain purchase option Lease term is 75% or more of economic life Present value of minimum lease payments is 90% or more of fair value Criteria Met? No No No No It is 40% (8 ? 20 years) It is 50% ($50,000 ? $100,000) Remarks Therefore, this lease is an operating lease.It does not meet any of the criteria. RE21-2 Rent put down funds 10,000 10,000 RE21-3 1. 2. 3. 4. Classification Criteria Transfer of ownership at end of lease Bargain purchase option Lease term is 75% or more of economic life Present value of minimum lease payments is 90% or more of fair value Criteria Met? No No No Yes It is 71% (5 ? 7 years) It is 100% ($250,000 ? $250,000) Remarks Therefore, this lease is a capital lease. It meets one of the four criteria. RE21-4 Jan, 1 leased Equipment Capital Lease obligation Dec. 31 delight outgo (10% x $250,000) Capital Lease pledge ($65,949. 7 $25,000) gold 250,000. 00 250,000. 00 25,000. 00 40,949. 37 65,949. 37 21-9 RE21-4 (continued) Depreciation write down undertake Equipment put in Depreciation Leased Equipment 50,000. 00* 50,000. 00 *The lessee depreciates the asset victimisation the straight-line manner over the lease term because there is no transfer of ownership or bargain purchase option, resulting in annual depreciation of $50,000 ($250,000 ? 5). RE21-5 Jan, 1 Leased Equipment Capital Lease Obligation Capital Lease Obligation specie Dec. 31 refer expenditure accrued divert on Capital Lease Obligation *($275,000 $65,949. 37) x 0. 0 Depreciation expense Leased Equipment Accumulated Depreciation Leased Equipment 55,000. 00* 55,000. 00 275,000. 00 65,949. 37 275 ,000. 00 65,949. 57 20,905. 06* 20,905. 06 *The lessee depreciates the asset using the straight-line method over the lease term because there is no transfer of ownership or bargain purchase option, resulting in annual depreciation of $55,000 ($275,000 ? 5). RE21-6 PV of lease payments = $25,000 x 6. 710081 = PV of single sum of $4,000 = $4,000 x 0. 463193 = Present value of minimum lease payments RE21-7 PV of lease payments = $25,000 x 6. 710081 = PV of single sum of $20,000 = $20,000 x 0. 63193 = Present value of minimum lease payments RE21-8 (a) (b) (c) Sales-type lease Direct financing lease Operating lease $167,752 9,264 $177,016 $167,752 1,853 $169,605 21-10 RE21-9 Jan, 1 Lease due ($65,949. 37 x 5) Equipment honorary wager Leases Dec. 31 coin Lease due Unearned invade Leases (0. 10 x $250,000) use up receipts Leases *($329,746. 85 $79,746. 85) x 0. 10 RE21-10 Jan, 1 Lease receivable Sales gross Unearned intimacy Leases represent of Asset Leased Merchandise Inventory (or Equipment Held for Lease) Dec. 31 gold Lease due Unearned reside Leases (0. 0 x $250,000) enkindle Revenue Leases *($329,746. 85 $79,746. 85) x 0. 10 329,746. 85 329,746. 85 250,000. 00 79,746. 85 65,949. 37 25,000. 00 65,949. 37 25,000. 00* 250,000. 00 79,746. 85 200,000. 00 200,000. 00 65,949. 37 25,000. 00 65,949. 37 25,000. 00* 21-11 SOLUTIONS TO EXERCISES Note to Instructor Although students may use their calculators or software to make the various present value calculations, any present value calculations in the following solutions to exercises and problems are based on the factors from the appropriate tables in the TVM Module of the book. E21-1 Criteria 1. . 3. 4. Transfer of ownership at end of lease Bargain purchase option 1. Determination of Lease Classification Met No No No Remarks Reverts to lessor Lease term is 75% or more of economic life Present value of lease payments is 90% or more of fair value 20% ( 10 year lease life ) 50 year economic life) No PV is $4 85,098. 79* or 24% of the fair value *PV = (Annual lease payment Annual executory costs) x PV factor for 10 payments at 14% = ($100,000 $7,000) x 5. 216116 = $485,098. 79 The lease is an operating lease, since none of the above criteria are met. 2. 2010 Dec. 2011 Dec. E21-2 1. . 31 Rent Expense immediate payment Rent Expense Cash 100,000 100,000 31 100,000 100,000 1. Determination of Lease Classification Criteria Transfer of ownership at end of lease Bargain purchase option Met No No Remarks 21-12 E21-2 (continued) 3. 4. Criteria Lease term is 75% or more of economic life Present value of lease payments is 90% or more of fair value Met Yes Remarks 100% Yes 100% The lease is a capital lease, since at least one of the Column A criteria is met. 2. Present value = Lease payments x PV factor for 5 payments at 12% (asset and liab) = $83,222. 92 x 3. 604776 = $300,000 (rounded) 3. 1) Date January 1, 2010 declination 31, 2010 declination 31, 2011 celestial latitude 31, 2012 December 31 , 2013 December 31, 2014 aColumn compendious of Lease Payments and amour Expense for the Sax companionship (2) Lease Payment need $83,222. 92 83,222. 92 83,222. 92 83,222. 92 83,222. 92 (3) (4) (5) Interest Expense Reduction at 12% on of Lease Balance of Obligation Balancea Obligationb Obligationc $300,000. 00 $36,000. 00 $47,222. 92 252,777. 08 30,333. 25 52,889. 67 199,887. 41 23,986. 49 59,236. 43 140,650. 98 16,878. 12 66,344. 80 74,306. 18 8,916. 74 74,306. 18 -0- 5 at beginning of year x 12%. Column 3. alance Column 4. 1 Leased Equipment Capital Lease Obligation Capital Lease Obligation Interest Expense (12% x $300,000) Cash 300,000 47,222. 92 36,000. 00 b$83,222. 92 cPrevious 4. 2010 Jan. Dec. 300,000 31 83,222. 92 21-13 E21-2 (continued) 4. (continued) Dec. 31 Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($300,000. 00 ? 5) Capital Lease Obligation Interest Expense (12% x $252,777. 08) Cash Depreciation Expense Leased Equipment Accumul ated Depreciation Leased Equipment 60,000 60,000 52,889. 67 30,333. 25 2011 Dec. 31 83,222. 92 31 60,000 60,000 5. Under U. S.GAAP, the Sax Company would classify the lease as an operating lease. The lease does not meet either of the first two criteria. The third amount is not met since the 3-year lease life is 60% of the economic life of 5 years. The fourth criterion is also not met since the present value of the lease payments of $264,201 ($110,000 x 2. 401831) is 88. 1% of the fair value of $300,000. Therefore, the lease would be an operating lease. Under IFRS, the Sax Company would have to exercise judgment but it is apt(predicate) that it would classify the lease as a finance lease since two of the indicators would probably be considered to be met.The present value of 88. 1% is probably substantially all of the fair value of the asset. Also, it could be argued that 60% is the major part of the economic life of the asset. E21-3 1. Application of Criteria for Determination of L ease Classification from Lessees Viewpoint multitude I Criteria 1. 2. 3. 4. Transfer of ownership Bargain purchase option Lease term is 75% or more of economic life Present value of lease payments is 90% or more of fair value* Met No No Yes 100% Remarks Yes 100% = $20,000 x PV factor for 4 payments in declare at 12% = $20,000 x 3. 401831 = $68,036. 62 21-14 *PV of minimum lease paymentsE21-3 (continued) 1. (continued) Since the lease meets at least one of the Column A criteria, it is a capital lease. 2. (1) epitome of Lease Payments and Interest Expense for the cast upen Company (2) (3) (4) Balance of Capital Lease Obligation $68,036. 62 48,036. 62a 53,801. 01c 33,801. 01 37,857. 13 17,857. 13 20,000. 00 0 Date January 1, 2010 January 1, 2010 December 31, 2010 January 1, 2011 December 31, 2011 January 1, 2012 December 31, 2012 January 1, 2013 a$68,036. 62 b$48,036. 62 c$48,036. 62 dAdjusted Interest at 12% Annual Lease on Unpaid Payment Obligation Before the initial payment $20, 000. 00 0 0 $5,764. 9b 0 20,000. 00 4,056. 12 0 0 20,000. 00 2,142. 87d 0 0 20,000. 00 $20,000 x 12% + $5,764. 39 for $0. 01 rounding error 1 1 Leased Equipment Capital Lease Obligation Capital Lease Obligation Cash Interest Expense increase Interest on Capital Lease Obligation Insurance Expense Property valuate Expense Cash 68,036. 62 20,000 5,764. 39 5,764. 39 1,500 6,000 3. 2010 Jan. 68,036. 62 20,000 Dec. 31 31 7,500 21-15 E21-3 (continued) 3. (continued) Dec. 31 Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($68,036. 62 ? 4) Accrued Interest on Capital Lease Obligation Capital Lease Obligation CashInterest Expense Accrued Interest on Capital Lease Obligation Insurance Expense Property assess Expense Cash Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment 17,009. 16 17,009. 16 2011 Jan. 1 5,764. 39 14,235. 61 4,056. 12 20,000. 00 Dec. 31 4,056. 12 1,300 5,500 31 6,800 31 17,009. 16 17,009. 16 E21-4 1. term of a c ontract receipt = = Fair value of assets PV factor for 8 receipts at 14% $500,000 4. 638864 = $107,785. 01 21-16 E21-4 (continued) 2. compact of Lease Payments true and Interest Revenue Earned by the Rexon Company (1) (2) Annual Lease Payment Received $107,785. 01 107,785. 01 107,785. 01 107,785. 1 107,785. 01 107,785. 01 107,785. 01 107,785. 01 (3) Interest Revenue at 14% on displace enthronement $70,000. 00a 64,710. 10 58,679. 61 51,804. 86 43,967. 63 35,033. 20 24,847. 95 13,236. 73f (4) Amount of Net Investment Recovered $37,785. 01b 43,074. 91 49,105. 40 55,980. 15 63,817. 38 72,751. 81 82,937. 06 94,548. 28 (5) Lease due $862,280. 08 754,495. 07c 646,710. 06 538,925. 05 431,140. 04 323,355. 03 215,570. 02 107,785. 01 -0(6) Unearned Interest Leases $362,280. 08 292,280. 08d 227,569. 98 168,890. 37 117,085. 51 73,117. 88 38,084. 68 13,236. 73 -0(7) Net Investment $500,000. 00 462,214. 99e 419,140. 08 370,034. 8 314,054. 53 250,237. 15 177,485. 34 94,548. 28 -0- Date January 1, 2010 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2013 December 31, 2014 December 31, 2015 December 31, 2016 December 31, 2017 a$500,000 21-17 x 14% $70,000. 00 $107,785. 01 $70,000. 00 b$107,785. 01 c$862,280. 08 d$362,280. 08 e$500,000 fAdjusted $37,785. 01 for $0. 03 rounding error 21-17 E21-4 (continued) 3. 2010 Jan. 1 Lease Receivable Equipment Unearned Interest Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases 862,280. 8 500,000. 00 362,280. 08 107,785. 01 70,000 Dec. 31 31 107,785. 01 70,000 2011 Dec. 31 31 107,785. 01 64,710. 10 107,785. 01 64,710. 10 E21-5 Proof that the yield is 1% PVn=48, i=1% is not given in textual matter it is 37. 973959 thus PV of lease payments received = Monthly lease payment x PV factor for 48 receipts at 1% = $1,600 x 37. 973959 = $60,758 (This is not required for the problem) 2010 Jan. 2 Lease Receivable Equipment Unea rned Interest Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases 1% x ($76,800 $16,042), (rounded) 76,800 0,758 16,042 1,600 31 1,600 31 608 608 21-18 E21-6 1. Annual lease payment = Cost of the equipmet PV factor for 5 years in produce at 14% = $30,000 3. 913712 = $7,665. 36 Summary Table (1) Lessee Company (2) Lease Payment Required Lease Rental Collected (3) Interest at 14% on Unpaid Obligation Interest at 14% on Net Investment (4) Balance of Lease Obligation Net Investmenta Lessor Company Date January 1, 2010 January 1, 2010 $7,665. 36 December 31, 2010 0 January 1, 2011 7,665. 36 December 31, 2011 0 January 1, 2012 7,665. 36 December 31, 2012 0 January 1, 2013 7,665. 6 December 31, 2013 0 January 1, 2014 7,665. 36 aPrevious balance Column 2 + Column 3 b$22,334. 64 cAdjusted 0 $3,126. 85b 0 2,491. 46 0 1,767. 11 0 941. 38c 0 $30,000. 00 22,334. 64 25,461. 49 17,796. 13 20,287. 59 12,622. 23 14,389. 34 6,723. 98 7,665. 36 0 x 14% for $0. 02 rounding error 21-19 E21-6 (continued) Date 01/01/10 12/31/10 12/31/11 12/31/12 12/31/13 1$7,665. 36 Lease Receivable $38,326. 801 30,661. 44 22,996. 08 15,330. 72 7,665. 36 x5 $30,000. 00 $3,126. 85 Unearned Net = Interest Leases Investment $8,326. 802 5,199. 953 2,708. 49 941. 38 0 $30,000. 00 25,461. 9 20,287. 59 14,389. 34 7,665. 36 2$38,326. 80 3$8,326. 80 2. Lessor Leasing Company 2010 Jan. 1 Lease Receivable ($7,665. 36 x 5) Equipment Unearned Interest Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases 38,326. 80 30,000. 00 8,326. 80 7,665. 36 3,126. 85 1 Dec. 31 7,665. 36 3,126. 85 Lessee Company 2010 Jan. 1 1 Leased Equipment Capital Lease Obligation Capital Lease Obligation Cash 30,000 7,665. 36 30,000 7,665. 36 21-20 E21-6 (continued) 2. (continued) Dec. 31 Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($30,000 ? ) Interest Expense Accrued Interest on Capital Lease Obligation Executory Costs (Expenses) Cash 6,000 6,00 0 3,126. 85 3,126. 85 500 500 31 31 E21-7 1. Selling price (fair value and the net investment) = $50,000 (PVn = 4, i = 12%) = $50,000 x 3. 037349 = $151,867. 45 2. Summary of lease receipts and interest revenue Information needed to prepare table rough-cut investment = Annual lease payment received x Number of payments = $50,000 x 4 = $200,000 Initial PV of the investment PV of lease payments (see 1) = $151,867. 45 Unearned interest revenue = crying(a) investment Initial PV of investment = $200,000 $151,867. 5 = $48,132. 55 = $151,867. 45 = $130,000. 00 Sales price = PV of minimum lease payments Cost of asset leased = Cost of equipment 21-21 E21-7 (continued) 2. (continued) Gross profit = Sales price Cost of asset leased = $151,867. 45 $130,000. 00 = $21,867. 45 (Table follows Requirement 3) 3. 2010 Jan. 1 Lease Receivable Sales Unearned Interest Leases Cost of Asset Leased Equipment Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable U nearned Interest Leases Interest Revenue Leases 200,000. 00 151,867. 45 48,132. 55 130,000. 00 50,000 18,224. 09 1 Dec. 31 31 2011 Dec. 30,000. 00 50,000 18,224. 09 31 31 50,000 14,410. 98 50,000 14,410. 98 21-22 E21-7 (continued) 2. Summary of Lease Payments Received and Interest Revenue Earned by the Berne Company (1) (2) Annual Lease Payment Received $50,000 50,000 50,000 50,000 (3) Interest Revenue at 12% on Net Investment $18,224. 09a 14,410. 98 10,140. 30 5,357. 18f (4) Amount of Net Investment Recovered $31,775. 91b 35,589. 02 39,859. 70 44,642. 82 (5) Lease Receivable $200,000 150,000c 100,000 50,000 -0(6) Unearned Interest Leases $48,132. 55 29,908. 46d 15,497. 48 5,357. 18 -0(7) Net Investment $151,867. 45 120,091. 54e 84,502. 52 44,642. 2 -0- Date January 1, 2010 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2013 a$151,867. 45 b$50,000 21-23 x 0. 12 $18,224. 09 $50,000 $18,224. 09 $31,775. 91 c$200,000 d$48,132. 55 e$151,867. 45 fAdjusted for $0. 04 rounding error 21-23 E21-8 1. Selling price (fair value) = $100,000 (PV in advance) n = 5, i = 14% = $100,000 (3. 913712) = $391,371. 20 2. Summary of lease payments received and interest revenue Information needed to prepare table Gross investment 20-24 = = = (Annual lease payment received x Number of payments) + Unguaranteed residual value ($100,000 x 5) + $20,000 $520,000Initial present value of the investment PV of lease payments (see part 1) PV of unguaranteed residual value $20,000 x PV of a single sum for 5 years at 14% $20,000 x 0. 519369 Total initial PV (this is also the net investment) Unearned interest leases $391,371. 20 10,387. 38 $401,758. 58 = Gross investment Initial PV of the investment = $520,000. 00 $401,758. 58 = $118,241. 42 Sales price = = Present value of lease payments $391,371. 20 (see part 1) = Cost of asset PV of the unguaranteed residual value = $313,000. 00 $10,387. 38 = $302,612. 62 Cost of asset leased 21-24 E21-8 (continued) 2. continued) Gros s profit = = = Sales price Cost of asset leased $391,371. 20 $302,612. 62 $ 88,758. 58 Summary of Lease Payments Received and Interest Revenue Earned by the Edom Company (1) (2) Annual Lease Payments Received $100,000. 00 100,000. 00 100,000. 00 100,000. 00 100,000. 00 (3) Interest Revenue at 14% on Net Investment (4) Lease Receivable $520,000. 00a 420,000. 00 320,000. 00 220,000. 00 120,000. 00 20,000. 00 (5) Unearned Interest Leases $118,241. 42b 75,995. 22 41,834. 55 16,891. 39 2,456. 18 0 (6) Net Investment $401,758. 58 301,758. 58 344,004. 78d 244,004. 78 278,165. 45 178,165. 45 203,108. 61 103,108. 61 117,543. 2 17,543. 82 20,000. 00f Date Jan. 1, 2010 Jan. 1, 2010 Dec. 31, 2010 Jan. 1, 2011 Dec. 31, 2011 Jan. 1, 2012 Dec. 31, 2012 Jan. 1, 2013 Dec. 31, 2013 Jan. 1, 2014 Dec. 31, 2014 a($100,000 b$520,000 $42,246. 20c 34,160. 67 24,943. 16 14,435. 21 2,456. 18e x 5) + $20,000 x 14% + $42,246. 20, or $420,000 $75,995. 22 residual value Lease Receivable Cost of Asset Leased S ales Equipment (or Inventory) Unearned Interest Leases 520,000. 00 302,612. 62 $401,758. 58 c$301,758. 58 d$301,758. 58 eAdjusted for $0. 05 rounding error fUnguaranteed 3. 2010 Jan. 1 391,371. 20 313,000. 00 118,241. 42 21-25 E21-8 (continued) 3. (continued) Jan. Dec. 011 Jan. Dec. E21-9 Summary Table for First 3 Months (1) Bullard Company Month Anson Company Month Beginning of 1 Beginning of 1 End of 1 Beginning of 2 End of 2 Beginning of 3 End of 3 (2) Lease Payment Required (3) Interest Expense (4) Balance of Lease Obligation 1 31 Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases 100,000 42,246. 20 100,000 42,246. 20 1 31 100,000 34,160. 67 100,000 34,160. 67 Lease Receipt $2,000 0 2,000 0 2,000 0 Interest Revenue 0 $588b 0 574 0 560 Net Investmenta $60,817 58,817 59,405c 57,405 57,979 55,979 56,539 1-26 E21-9 (continued) Receivable $70,0001 68,000 66,000 64,000 1($2,000 2$58,817 b1% aLe ase Unearned = Interest Leases $9,183 8,595 8,021 7,461 Net Investment $60,8172 59,405 57,979 56,539 x 35) + $2,000 + $588 Lease Receivable Sales ($58,817 + $2,000) Unearned Interest Leases ($72,000 $60,817) Cost of Asset Leased Merchandise Inventory 72,000 60,817 11,183 50,000 2,000 588 2,000 574 2,000 560 50,000 2,000 588 2,000 574 2,000 560 x $58,817 c$58,817 1. At blood line Initial receipt At end of 1st month Cash Lease Receivable Unearned Interest Leases Interest Revenue LeasesSecond Cash Installment Lease Receivable At end of Unearned Interest Leases second month Interest Revenue Leases Third Cash installment Lease Receivable At end of 3rd month Unearned Interest Leases Interest Revenue Leases 21-27 E21-9 (continued) 2. Computation of Lessees Obligation Using the Implicit Interest Rate PV of lease payments = $ 2,000 + PV of remaining 35 payments of $2,000 each at 1% = $ 2,000 + $58,817 = $60,817* *Note By definition, the present value of the lease payments equals the init ial payment plus the present value of the remaining lease payments, since the initial payment is at the beginning of the period.At inception Initial payment At end of 1st month Leased Equipment Capital Leases Obligation Capital Lease Obligation Cash Interest Expense Accrued Interest on Capital Lease Obligation Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($60,817 ? 36) Second Accrued Interest on installment Capital Lease Obligation Capital Lease Obligation Cash At end of Interest Expense 2nd month Accrued Interest on Capital Lease Obligation Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment 60,817 2,000 588 588 1,689 1,689 588 1,412 574 574 1,689 1,689 60,817 2,000 ,000 21-28 E21-9 (continued) 2. (continued) Third Accrued Interest on installment Capital Lease Obligation Capital Lease Obligation Cash At end of 3rd month Interest Expense Accrued Interest on Capital Lease Obligation Depreciation Expense Leased Equipment A ccumulated Depreciation Leased Equipment E21-10 Computation of the effect on income before income taxes using the sales-type lease method Sales = PV of lease payments receivable = (PV factor for 8 payments in advance at 12%) x $60,000 = 5. 563757 x $60,000 = $333,825 Cost of asset leased = = Cost of the property $275,000 574 1,426 560 560 1,689 1,689 ,000 21-29 E21-10 (continued) Interest revenue leases = 12% x (Lease receivable Initial payment) Unearned interest leases = 12% x ($60,000 x 8) $60,000) (Lease rec. Sales) = 12% x ($420,000 $146,175) = $32,859 Incremental effect on income before income taxes Sales Less Cost of asset leased Gross margin Add Interest revenue Incremental revenue recognized $333,825 (275,000) $ 58,825 32,859 $ 91,684 Computation of the effect on income before income taxes using the operating lease method Rental revenue Depreciation expense = $60,000. 0 = = Cost Residual Value Economic life $275,000 $0 8 = $34,375 Incremental effect on income before i ncome taxes Rental revenue $60,000 Less Depreciation expense (34,375) $25,625 Effect on income before income taxes Sales-type lease income Operating lease income Income before income taxes $91,684 (25,625) $66,059 understated 21-30 E21-11 1. Computation of Income Before Income Taxes Derived by Reuben Company for division Ended December 31, 2010 Rental revenue Maintenance expense Depreciation expense Income before income taxes *10/12 x $180,000 $900,000 150,000* (20,000) (90,000) $ 40,000 ? 10 (It should be depreciated for a full year) 2. Rent expense = 10/12 x $180,000 = $150,000 E21-12 1. Application of Criteria for Determination of Lease Classification from Lessors Viewpoint Column A Criteria 1. Transfer of ownership at end of lease 2. Bargain purchase option 3. Met Yes No Yes 80% ( Remarks Lease term is 75% or more of economic life 4 year lease life ) 5 year economic life 4. Present value of lease payments is 90% or more of fair value Column B Criteria 1. Collectibility assured 2.No uncertainties Yes Present value is $8,400, or 100% of the fair value Yes Yes Since the lease meets at least one of the Column A criteria and both of the Column B criteria, and there is no dealers profit (PV of lease payments Cost of car = $8,400 $8,400 = $0), the transaction should be classified as a direct financing lease. 21-31 E21-12 (continued) 2. Summary of lease payments received and interest revenue Computation of amount of lease receipts Yearly lease receipt = Cost of the car PV factor for 4 payments at 10% $8,400 3. 169865 = $2,649. 96 (Table follows Requirement 3) 3. 2010 Jan. 1 1 Automobile Held for Lease Cash Lease Receivable Automobile Held for Lease Unearned Interest Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases (from table) Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases (from table) 8,400. 00 10,599. 84 8,400. 00 8,400. 00 2,199. 84 2,649. 96 Dec. 31 31 2,649. 96 840. 00 840. 00 2,649. 96 659. 00 659. 00 2 011 Dec. 31 31 2,649. 96 21-32 E21-12 (continued) 2.Summary of Lease Payments Received and Interest Revenue Earned by the Ravis Rent-A-Car Company (by Interest Method) (1) (2) Annual Lease Payments Received $2,649. 96 2,649. 96 2,649. 96 2,649. 96 (3) Interest Revenue at 10% on Net Investment $840. 00a 659. 00 459. 90 240. 94f (4) Amount of Net Investment Recovered $1,809. 96b 1,990. 96 2,190. 05 2,409. 02 (5) Lease Receivable $10,599. 84 7,949. 88c 5,299. 92 2,649. 96 -0(6) Unearned Interest Leases $2,199. 84 1,359. 84d 700. 84 240. 94 -0(7) Net Investment $8,400. 00 6,590. 04e 4,599. 08 2,409. 02Date January 1, 2010 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2013 a$8,400. 00 b$2,649. 96 21-33 x 10% $840. 00 $2,649. 96 $840. 00 $1,809. 96 c$10,599. 84 d$2,199. 84 e$8,400. 00 fAdjusted for $0. 04 rounding error 21-33 E21-13 1. Present value of lease payments = $10,000 x PV factor for 6 payments at 10% = $10,000 x 4. 355261 = $43,552 (rounded down for simp licity) = $50,000 fair value of the machine $43,552 = $6,448 = $6,448 x FV of 1 factor for 6 periods at 10% = $6,448 x 1. 771561 = $11,421 (rounded) Present value of residual valueResidual value at the end of the lease term 2. 20-34 Since the first three criteria are not met, the classification of the lease depends on the fourth criterion. A guaranteed residual value is not included in the minimum lease payments. Therefore, Baker Company would classify the lease as a capital lease because the fourth criterion is met as follows Present value of minimum lease payments = = $43,552 + $6,448 $50,000, or 100% of the fair value of the machine 3. Since the first three criteria are not met, the classification of the lease depends on the fourth criterion.An unguaranteed residual value is included in the minimum lease payments. Therefore, Baker Company would classify the lease as an operating lease because the fourth criterion is not met as follows Present value of minimum lease payments = $4 3,552, or 87. 1% of the fair value of the machine E21-14 1. 2010 Jan. 1 Cash repose Unearned Profit on Sales-Leaseback Leased Land Capital Lease Obligation Insurance and Property Tax Expense Cash 31 Capital Lease Obligation Interest Expense Leases (14% x $2,500,000) Cash 21-34 2,500,000 2,000,000 500,000 2,500,000 12,000 1 During the year Dec. ,500,000 12,000 7,007 350,000 357,007 E21-14 (continued) 2. The $500,000 unearned profit is amortized by the straight-line method over the 25 year term of the lease. The yearly entry is 2010 Dec. 31 Unearned Profit on Sales Leaseback Realized Profit on Sales Leaseback 20,000 20,000 21-35 SOLUTIONS TO PROBLEMS P21-1 1. Application of Criteria for Determination of Lease Classification Column A Criteria 1. Transfer of ownership at end of lease 2. Bargain purchase option 3. Met No No No Remarks Lease term is 75% or more of economic life 5 year lease life 50% ( ) 10 year economic lifePV of $268,685. 58* is 88% of fair value 4. Present value of lease payments is 90% or more of fair value *PV No = (Yearly lease payments Executory costs) x PV factor for 5 payments in advance at 12% = ($70,000 $3,450) x 4. 037349 = $66,550 x 4. 037349 = $268,685. 58 This lease is an operating lease for both the Alice Company (lessee) and the Superior Equipment Company (lessor). Reasons None of the Column A criteria are met. 2. Alice Company (lessee) 2010 Jan. 1 Rent Expense Cash 70,000 70,000 21-36 P21-1 (continued) 2. (continued) Superior Equipment Company (lessor) 2011 Jan.During the year Dec. 31 1 Cash Rental Revenue Property Tax Expense Maintenance Expense Insurance Expense Cash 70,000 650 1,600 1,200 70,000 3,450 Depreciation Expense Equipment 49,500 Accumulated Depreciation Equipment ($500,000 $5,000) ? 10 Application of Criteria for Determination of Lease Classification 49,500 3. Column A Criteria 1. Transfer of ownership at end of lease 2. Bargain purchase option 3. Met No No No Remarks Lease term is 75% or more of economic life 5 year lease life 50% ( ) 10 year economic life PV of $305,000* (rounded) 100% of fair value . Present value of lease payments is 90% or more of fair value *PV Yes = (Yearly lease payments Executory costs) x PV factor for 5 payments in advance at 12% + PV of guaranteed residual value = = = = ($70,000 $3,450) x 4. 037349 + ($64,000 x 0. 567427) ($66,550 x 4. 037349) + $36,315. 33 $268,685. 57 + $36,315. 33 $305,000 (rounded) This lease is a capital lease for both the Alice Company (lessee) and the Superior Equipment Company (lessor). Reasons The lessee would classify the lease as a capital lease because one of the Column A criteria is met. The lessor would classify the lease as a direct financing lease because (a) one of the Column A criteria is met, (b) both of the Column B criteria are met, and (c) there is no profit at the inception of the lease (fair value = present value of the minimum lease payments). 21-37 P21-1 (continued) 3. (continued) Alice Company (lessee) 2010 Jan. 1 1 Leased Equipment Capital Lease Obligation Executory Costs Expense Capital Lease Obligation Cash Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($305,000 $64,000) ? Interest Expense 12% x ($305,000 $66,550) Accrued Interest on Capital Lease Obligation Executory Costs Expense Accrued Interest on Capital Lease Obligation Capital Lease Obligation Cash Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment Interest Expense 12% x ($305,000 $66,550 $37,936) Accrued Interest on Capital Obligation 305,000 3,450 66,550 305,000 70,000 Dec. 31 48,200 48,200 28,614 28,614 3,450 28,614 37,936 31 2011 Jan. 1 70,000 Dec. 31 48,200 48,200 24,061. 68 24,061. 68 31 21-38 P21-1 (continued) 3. continued) 2014 Dec. 31 Capital Lease Obligation Cash 64,000 64,000 Superior Equipment Company (lessor) 2010 Jan. 1 1 Equipment Leased to Others Cash Lease Receivable ($66,550 x 5 + $64,000) Equipment Leased to Others Unearned Interest Leases Cash Leas e Receivable Property Tax Expense Maintenance Expense Insurance Expense Cash Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Property Tax Expense Maintenance Expense Insurance Expense Cash Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable 305,000 305,000 396,750 05,000 91,750 66,550 1 During The Year Dec. 31 2011 Jan. During The Year Dec. 31 2014 Jan. 66,550 650 1,600 1,200 28,614 3,450 28,614 1 66,550 650 1,600 1,200 24,061. 68 66,550 3,450 24,061. 68 1 64,000 64,000 21-39 P21-2 1. Application of Criteria for Determination of Lease Classification Column A Criteria 1. 2. 3. 4. Transfer of ownership at end of lease Bargain purchase option Lease term is 75% or more of economic life Present value of lease payments is 90% or more of fair value Met No Yes Yes 100% Present value is $185,090. 68 or 100% of fair value Remarks YesThis is a sales-type lease for Ballieu Company, since one or more of the Column A criteria are met, both of the Column B criteria are met, and there is a dealers profit (PV of lease payments Cost of asset = $185,090. 68 $150,000 = $35,090. 68) 2. (1) Two-Year Table of Lease Payment Receipts and Interest Revenue Recognition (2) Annual Lease Payments Received $35,000. 00 35,000. 00 (3) Interest Revenue at 14% on Net Investment (4) Lease Receivable $280,000. 00a 245,000. 00 210,000. 00 (5) Unearned Interest Leases $94,909. 32b 73,896. 62 (6) Net Investment $185,090. 8 150,090. 68 171,103. 38d 136,103. 38 155,157. 85 Date Jan. 1, 2010 Jan. 1, 2010 Dec. 31, 2010 Jan. 1, 2011 Dec. 31, 2011 a$35,000 $21,012. 70c 19,054. 47 x8 $185,090. 68 x 14% + $21,012. 70 b$280,000 c$150,090. 68 d$150,090. 68 21-40 P21-2 (continued) 2. (continued) 2010 Jan. 1 Lease Receivable ($35,000 x 8) Sales Unearned Interest Leases ($280,000 $185,090. 68) Cost of Asset Leased Specialty Equipment (Inventory) Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Inter est Revenue Leases 280,000. 0 185,090. 68 94,909. 32 1 1 Dec. 2011 Jan. Dec. 3. 31 150,000. 00 35,000 21,012. 70 150,000. 00 35,000 21,012. 70 1 31 35,000 19,054. 47 35,000 19,054. 47 The lessor must disclose a. A general description of the leasing arrangements b. (1) The components of the net investment at the date of each balance sheet presented (a) The future lease payments to be received (b) The unearned interest revenue leases (2) Future lease payments to be received for each of the 5 succeeding fiscal years as of the date of the latest balance sheet presented P21-3 1.Present value = Lease payments x PV factor for 5 payments at 12% (asset and liab) = $83,222. 92 x 3. 604776 = $300,000 (rounded) 21-41 P21-3 (continued) 2. (1) Date January 1, 2010 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2013 December 31, 2014 a$300,000 Summary Table of Lease Payments and Interest Expense for Timmer Company (2) Lease Payment Required $83,222. 92 83,222. 92 83,222. 92 83, 222. 92 83,222. 92 (3) Interest Expense at 12% on Obligation Balancea $36,000. 00a 30,333. 25 23,986. 49 16,878. 12 8,916. 74d (4) Reduction of Lease Obligation $47,222. 2b 52,889. 67 59,236. 43 66,344. 80 74,306. 18 (5) Balance of Lease Obligation $300,000. 00 252,777. 08c 199,887. 41 140,650. 98 74,306. 18 -0- x 12% $36,000. 00 $47,222. 92 b$83,222. 92 c$300,000. 00 3. 2010 Jan. Dec. 1 31 Leased Equipment Capital Lease Obligation Capital Lease Obligation Interest Expense Cash Insurance Expense Property Tax Expense Cash Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($300,000. 00 ? 5) Capital Lease Obligation Interest Expense Cash Insurance Expense Property Tax Expense Cash 21-42 300,000 47,222. 2 36,000. 00 3,760 5,440 300,000 83,222. 92 31 9,200 31 60,000 60,000 52,889. 67 30,333. 25 3,100 5,330 2011 Dec. 31 83,222. 92 31 8,430 P21-3 (continued) 3. (continued) Dec. 31 Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipmen t TIMMER COMPANY Balance Sheet (Partial) December 31, 2010 Assets Property, Plant, and Equipment Leased property less accumulated amortization $240,000. 00 (Note X) a$83,222. 92 60,000 60,000 4. Liabilities Current Capital lease obligation Noncurrent Capital lease obligation (Note X) $ 74,306. 17a,c $178,470. 1b,c x 0. 892857 $74,306. 17 b$252,777. 08 cThese amounts computed by the change in present value approach are $52,889. 67 and $199,887. 41, respectively Under U. S. GAAP, the Timmer Company would classify the lease as an operating lease. The lease does not meet either of the first two criteria. The third criterion is not met since the 3-year lease life is 60% of the economic life of 5 years. The fourth criterion is also not met since the present value of the lease payments of $269,507 ($120,000 x 2. 245890) is 89. 8% of the fair value of $300,000.Therefore, the lease would be an operating lease. Under IFRS, the Timmer Company would have to exercise judgment but it is likely t hat it would classify the lease as a finance lease since two of the indicators would probably be considered to be met. The present value of 89. 8% is probably substantially all of the fair value of the asset. Also, it could be argued that 60% is the major part of the economic life of the asset. 5. 21-43 P21-4 1. Summary Table of Lease Payments Received and Interest Revenue Earned by the Calden Company (1) (2) Lease Payment Received $65,000. 0 65,000. 00 65,000. 00 65,000. 00 65,000. 00 65,000. 00 65,000. 00 65,000. 00 (3) Interest Revenue at 15% on Net Investment $46,203. 16c 43,383. 63 40,141. 17 36,412. 35 32,124. 20 27,192. 83 21,521. 76 14,999. 87h (4) Reduction of Net Investment $18,796. 84d 21,616. 37 24,858. 83 28,587. 65 32,875. 80 37,807. 17 43,478. 24 50,000. 13 (5) Lease Receivable $570,000a 505,000e 440,000 375,000 310,000 245,000 180,000 115,000 50,000 (6) Unearned Interest Leases $261,978. 97 215,775. 81f 172,392. 18 132,251. 01 95,838. 66 63,714. 46 36,521. 63 14,999. 7 -0(7) Net Investment $308,021. 03b 289,224. 19g 267,607. 82 242,748. 99 214,161. 34 181,285. 54 143,478. 37 100,000. 13 50,000. 00i Date January 1, 2010 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2013 December 31, 2014 December 31, 2015 December 31, 2016 December 31, 2017 a$570,000 21-44 is the undiscounted value of the lease payments plus the unguaranteed residual value is the present value of the lease payments plus the present value of the unguaranteed residual x 15% b$308,021. 03 value c$308,021. 03 d$65,000. 00 e$570,000 $46,203. 16 $46,203. 16 $18,796. 84 residual value $65,000 f$261,978. 97 g$308,021. 03 hAdjusted for $0. 15 rounding error iUnguaranteed 21-44 P21-4 (continued) 2. Criteria for direct financing lease Application of Criteria for Determination of Lease Classification Column A Criteria 1. Transfer of ownership at end of lease 2. Bargain purchase option 3. Lease term is 75% or more of eonomic life 4. Present value of lease payments is 90% or more of fair value *PV of minimum lease payments Met No No Yes 89% ( 8 year lease life ) 9 year economic life Remarks 0-45 Yes PV is 94. 7% of the fair value of the leased asset* = $65,000 x PV factor for 8 payments at 15% = $65,000 x 4. 487322 = $291,675. 93 Column B Criteria 1. Collectibility assured 2. No uncertainties Met Yes Yes Remarks The lease is in good order classified as a direct financing lease because at least one of the Column A criteria is met, both of the Column B criteria are met, and there is no dealers profit. 3. 2010 Jan. 1 1 Equipment Leased to Others Cash Lease Receivable ($520,000 + $50,000) Equipment Leased to Others Unearned Interest Leases 308,021. 3 308,021. 03 570,000 308,021. 03 261,978. 97 21-45 P21-4 (continued) 3. (continued) Dec. 31 31 2011 Dec. Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Interest Rev enue Leases CALDER COMPANY Balance Sheet (Partial) Assets Current Assets Net investment in direct financing leases (Note X) Noncurrent Assets Net investment in direct financing leases (Note X) a$65,000 65,000 46,203. 16 5,000 46,203. 16 31 31 65,000 43,383. 63 65,000 43,383. 63 2012 Dec. 31 31 65,000 40,141. 17 65,000 40,141. 17 4. December 31, 2011 2010 $ 56,521. 73a,d $ 56,521. 73a,c $211,086. 09b,d $232,702. 46b,c x 0. 869565 $289,224. 19 $56,521. 73 12/31/11 $267,607. 82 $56,521. 73 b12/31/10 cThese amounts computed by the change in present value approach are $21,616. 37 and $267,607. 82, respectively amounts computed by the change in present value approach are $24,858. 83 and $242,748. 99, respectively dThese 21-46 P21-5 1. a) Landlord Company computation of annual rental amount Annual rental amount = = Cost of equipment PV factor for 6 receipts in advance at 14% $300,000 4. 433081 = $67,673. 02 (b) Tenant Company computation of the present value of the lease rights To find t he present value of the lease rights, Tenant Company would reckon the annual rental payment ($67,673. 02) by the PV factor for 6 periods paid in advance at i%. The percentage i would be the lower of 14% or Tenant Companys incremental borrowing rate. This incremental borrowing rate is the additional information needed.Summary Table of Lease Payments Received and Interest Revenue Recognition for the Landlord Company (1) (2) Annual Lease Payments Received $67,673. 02 67,673. 02 67,673. 02 67,673. 02 67,673. 02 67,673. 02 2. Date Jan. 1, 2010 Jan. 1, 2010 Dec. 31, 2010 Jan. 1, 2011 Dec. 31, 2011 Jan. 1, 2012 Dec. 31, 2012 Jan. 1, 2013 Dec. 31, 2013 Jan. 1, 2014 Dec. 31, 2014 Jan. 1, 2015 a$67,673. 02 (3) Interest Revenue at 14% on Net Investment (4) Lease Receivable $406,038. 12a 338,365. 10 270,692. 08 203,019. 06 135,346. 04 67,673. 02 0 (5) Unearned Interest Leases $106,038. 12b 73,512. 4 45,907. 18 23,911. 52 8,310. 69 0 (6) Net Investment $300,000. 00 232,326. 98 264,852. 76d 197, 179. 74 224,784. 90 157,111. 88 179,107. 54 111,434. 52 127,035. 35 59,362. 33 67,673. 02 0 $32,525. 78c 27,605. 16 21,995. 66 15,600. 83 8,310. 69e x6 $300,000. 00 x 14% d$232,326. 98 eAdjusted + $32,525. 78 b$406,038. 12 c$232,326. 98 for $0. 04 rounding error This table would also be suitable for Tenant Company if Tenants incremental borrowing rate is ? 14%. 21-47 P21-5 (continued) 3. Journal entries Tenant Company (lessee) 2010 Jan. 1 1 During the year Dec. 1 Leased Equipment Capital Lease Obligation Capital Lease Obligation Cash Insurance Expense Property Tax Expense Cash Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment ($300,000 ? 6) Interest Expense Accrued Interest on Capital Lease Obligation Accrued Interest on Capital Lease Obligation Capital Lease Obligation Cash Insurance Expense Property Tax Expense Cash 31 Depreciation Expense Leased Equipment Accumulated Depreciation Leased Equipment Interest Expense Accrued Interest on Capital Lease Ob ligation 300,000 67,673. 2 700 800 300,000 67,673. 02 1,500 50,000 50,000 32,525. 78 32,525. 78 31 2011 Jan. 1 32,525. 78 35,147. 24 600 750 67,673. 02 During the year Dec. 1,350 50,000 50,000 27,605. 16 27,605. 16 31 21-48 P21-5 (continued) 3. (continued) Landlord Company (lessor) 2010 Jan. 1 1 Equipment Leased to Others Cash Lease Receivable ($67,673. 02 x 6) Equipment Leased to Others Unearned Interest Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases Cash Lease Receivable Unearned Interest Leases Interest Revenue Leases 300,000. 0 406,038. 12 300,000. 00 300,000. 00 106,038. 12 67,673. 02 32,525. 78 1 Dec. 2011 Jan. Dec. 4. 31 67,673. 02 32,525. 78 1 31 67,673. 02 27,605. 16 67,673. 02 27,605. 16 Income statements and balance sheets Tenant Company Disclosure (Lessee) Comparative Balance Sheets (Partial) December 31 Assets 2011 2010 Liabilities 2011 2010 Leased equipment less accumulated amortization (Notes 1 and 2) $200,000. 00 $250,000. 00 Current Ca pital lease obligation $ 67,673. 02 Noncurrent Capital lease obligation 157,111. 88 (Notes 1 and 2) $ 67,673. 02 197,179. 74