Intermediate Accounting: Reporting And Analysis
Intermediate Accounting: Reporting And Analysis
3rd Edition
ISBN: 9781337788281
Author: James M. Wahlen, Jefferson P. Jones, Donald Pagach
Publisher: Cengage Learning
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Chapter 20, Problem 12P

Comprehensive Landlord Company and Tenant Company enter into a noncancelable, direct financing lease on January 1, 2019, for nonspecialized equipment that cost the Landlord $280,000 (useful life is 6 years with no residual value). The fair value of the equipment is $300,000. The interest rate implicit in the lease is 14%. The 6-year lease requires 6 equal annual amounts payable each January 1, beginning with January 1, 2019. Tenant pays all executory costs directly to a third party on December 1 of each year. The equipment reverts to the lessor at the termination of the lease. Assume that there are no initial direct costs. Landlord expects to collect all rental payments.

Required:

  1. 1. Next Level (a) Show how landlord should compute the annual rental amounts, (b) Discuss how the Tenant Company should compute the present value of the lease payments. What additional information would be required to make this computation?
  2. 2. Next Level Prepare a table summarizing the lease and interest receipts that would be suitable for Landlord. Under what conditions would this table be suitable for Tenant?
  3. 3. Assuming that the table prepared in Requirement 2 is suitable for both the lessee and the lessor, prepare the journal entries for both firms for the years 2019 and 2020. Use the straight-line depreciation method for the leased equipment. The executory costs paid by the lessee are in 2019: insurance, $700 and property taxes, $800; in 2020: insurance, $600 and property taxes, $750.
  4. 4. Next Level Show the items and amounts that would be reported on the comparative 2019 and 2020 income statements and ending balance sheets for both the lessor and the lessee, using the change in present value approach.

1 (a)

Expert Solution
Check Mark
To determine

Calculate the annual rental amounts.

Explanation of Solution

Compute the annual rental amount of Company L, as follows:

Annul Rental Amount = Cost of EquipmentPV factor for 6 receipts in advance at 14%$300,0004.433081                                  = $67,673.02

Therefore, annual rental amount is $67,673.02.

1 (b)

Expert Solution
Check Mark
To determine

Explain the way Company T should compute the present value of the lease rights and additional information required to make such calculation.

Explanation of Solution

To determine the present value of the lease rights, Company T should multiply the annual rental payment of $67,673.02 by the PV factor for 6 periods in advance at x%. That x% would be lesser than 14% or incremental borrowing rate of the Company T. Thus the incremental borrowing rate for Company T is the required additional information to compute the PV of lease rights.

2.

Expert Solution
Check Mark
To determine

Prepare the table summarizing the lease and interest receipts that would be suitable for Company L.

Explanation of Solution

Prepare the table summarizing the lease and interest receipts that would be suitable for Company L:

Date

(1)

Lease payment received

(2)

Interest revenue at 14%

(3)

Net investment

(4)

January 1,2019  $300,000.00
January 1,2019$67,673.02 232,326.98
December31,2019 $32,525.78264,852.76
January 1,2020$67,673.02 197,179.74
December31,2020 27,605.16224,784.90
January 1,2021$67,673.02 157,111.88
December31,2021 21,995.66179,107.54
January 1,2022$67,673.02 111,434.52
December31,2022 15,600.83127,035.35
January 1,2023$67,673.02 59,362.33
December31,2023 8,310.6967,673.02
January 1,2024$67,673.02 0.00

Table (1)

Notes for the above table:

Interest Revenue on Net Investment(December 31,2016) = $232,326.98×14%

Net Investment(Decemnber 31,2016) = $232,326.98+$32,525.78Interest Revenue on Net Investment(December 31,2020) is adjusted for $0.04 rounding error.

The aforesaid table would also be suitable for Company T, if the incremental borrowing rate is 14% rate of return in the lease.

3.

Expert Solution
Check Mark
To determine

Prepare journal entries suitable for Company L and Company T for the years 2016 and 2017.

Explanation of Solution

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit: Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

  • Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
  • Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Prepare journal entries suitable for Company L and Company T for the years 2016 and 2017:

In the books of lessee Company T:

DateAccounts title and explanationPost Ref.Debit ($)Credit ($)
January 1,2019Right of use asset 300,000.00 
    Lease liability  300,000.00
(To record the capital lease at inception)   
 
January 1,2019Lease liability 67,673.02 
    Cash  67,673.02
(To record the capital lease payment)   
 
December 01, 2019Insurance Expense 700.00 
Property Tax Expense 800.00 
    Cash  1,500.00
(To record the payment for executory costs)   
 
December 31, 2019Amortization expense ($30,000/6) 50,000.00 
    Right of use asset  50,000.00
(To record the depreciation expense)   
    
December 31, 2019Interest Expense 32,525.78 
    Lease liability  32,525.78
(To record the interest expense)   
 
January 1,2020Lease liability 67,673.02 
    Cash  67,673.02
(To record the payment of accrued interest and lease payment)   
 
December 01, 2020Insurance Expense 600.00 
Property Tax Expense 750.00 
    Cash  1,350.00
(To record the payment for executory costs)   
 
December 31, 2020Amortization expense 50,000.00 
    Right of use asset  50,000.00
(To record the depreciation expense)   
 
December 31, 2020Interest Expense 27,605.16 
    Lease liability  27,605.16
(To record the interest expense)   

Table (2)

In the books of Lessor (Company L):

DateAccounts title and explanationPost Ref.Debit($)Credit($)
January 01, 2019Lease receivable 300,000.00 
    Sales revenue  300,000.00
 (To record the lease at inception)   
     
January 01, 2019Cost of goods sold $280,000 
    Equipment Leased to Others  $280,000
 (To record the lease receivable in a capital lease)   
     
January 01, 2019Cash 67,673.02 
    Lease Receivable  67,673.02
 (To record the receipt lease payment)   
     
December31, 2019Lease receivable 32,525.78 
    Interest Revenue: Leases  32,525.78
 (To recognize the interest revenue for the year)   
  
January 1,2020Cash 67,673.02 
    Lease Receivable  67,673.02
 (To record the receipt lease payment)   
  
December 31, 2020Lease Receivable 27,605.16 
    Interest Income  27,605.16
 (To recognize the interest revenue for the year)   

Table (3)

4.

Expert Solution
Check Mark
To determine

Prepare income statements and ending balance sheets for both Company L and Company T for the year 2016 and 2017 with appropriate notes.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Balance Sheet:  Balance Sheet is one of the financial statements which summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Income statements and ending balance sheets for Company T:

Company T
Comparative Income statement(Partial)
For the year ended December 31
 20202019
Interest Expense$27,605.16 $32,525.78
Insurance Expense600.00700.00
Property Tax Expense750.00800.00
Depreciation Expense50,000.0050,000.00
 
Comparative Balance Sheet(Partial)
As on December 31
 20202019
Assets  
Right of use asset   
(Notes 1 and 2)$200,000.00$250,000.00
   
Liabilities and Shareholders’ equity  
Current:  
Capital Lease Obligation$67,673.02 $67,673.02
Non-Current:  
Capital Lease Obligation(Notes 1 and 2)$157,111.88$197,179.74

Table (4)

Note 1: Description of Right of use asset:

Company T is leasing heavy equipment from Company L. The lease term is 6 years and 4 years are still remaining. There are no restrictions and no purchase option too in the lease. The heavy equipment reverts to Company L once the lease period is over.

Note 2: financial Leases:

The leased property details are as follows:

 31.12.202031.12.2019
Leased Equipment$300,000.00$300,000.00
Less: Accumulated amortization$100,000.00$50,000.00
Balance$200,000.00$250,000.00

Table (5)

Income statements and ending balance sheets for Company L:

Company L
Comparative Income statement(Partial)
For the year ended December 31
 20202019
Revenue:  
Interest Revenue: Leases27,605.1632,525.78
   
   
Comparative Balance Sheet (Partial)
As on December 31st
 20202019
Current Assets  
Net investment in direct financing leases  
(Notes 3 and 4)$67,673.02 $67,673.02
   
Non-Current Assets:  
Net Investment in direct financing leases  
(Notes3 and 4)$157,111.88$197,179.74

Table (7)

Note 3: Description of leasing arrangements:

Company L has leased the heavy equipment to Company T. The lease term is 6 years and 4 years are remaining. The heavy equipment reverts to Company L after the expiry of the lease.

Note 4: Net Investment in direct financing leases:

Following are the components of net investments in direct financing leases as on December 31 of the years as depicted in the schedule below:

 20202019
Total lease payment receivable$270,692.08$338,365.10
Less: Unearned interest: leases45,907.1873,512.34
Total lease payment receivable(net)$224,784.90$264,852.76

Table (8)

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Chapter 20 Solutions

Intermediate Accounting: Reporting And Analysis

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