ACC3100 15 Leases PDF

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Chapter 15 Leases...

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1 A  merican Food Services, Inc. leased a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2021. The lease agreement for the $4 million (fair value and present value of the lease payments) machine specified four equal payments at the end of each year. The useful life of the machine was expected to be four years with no residual value. Barton and Barton’s implicit interest rate was 10%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Prepare the journal entry for American Food Services at the beginning of the lease on January 1, 2021.

2. Prepare an amortization schedule for the four-year term of the lease. ** PVOA of $1: n=4,i=10%

$4,000,000

÷

3.16987**

3. & 4. Lease entries on Dec 31, 2021 and 2023. December 31, 2021 Interest expense (10% × outstanding balance) = 400,000 Amortization expense ($4 million ÷ 4 years) = 1,000,000

December 31, 2023 Interest expense (10% × outstanding balance) = 219,005 Amortization expense ($4 million ÷ 4 years) = 1,000,000

=

$1,261,881 present value

=lease payment

2  On June 30, 2018, Georgia-Atlantic, Inc. leased warehouse equipment from IC Leasing Corporation. The lease agreement calls for Georgia-Atlantic to make semiannual lease payments of $562,907 over a three-year lease term, payable each June 30 and December 31, with the first payment at June 30, 2021. Georgia-Atlantic's incremental borrowing rate is 10%, the same rate IC uses to calculate lease payment amounts. Amortization is recorded on a straight-line basis at the end of each fiscal year. The fair value of the equipment is $3 million. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1)

Part 1 1. Determine the present value of the lease payments at June 30, 2021 that Georgia-Atlantic uses to record the right-of-use asset and lease liability. Present value

$3,000,000

Present value of lease payments = $562907 × 5.32948 = $3000000 (rounded) Liability

$1996041 PRETAX AMOUNT FOR LIABILITY

Asset

$2500000 PRETAX AMOUNT FOR RIGHT-OF-USE ASSET

Part 2. Present value of an annuity due of $1: n = 6, i = 5% is 5.32948 2. What pretax amounts related to the lease would Georgia-Atlantic report in its balance sheet at Dec 31, 2021? Liability at December 31, 2021 Initial balance, June 30, 2021

3000000

June 30, 2021 reduction 

(562907)

Dec. 31, 2021 reduction (562907-((3000000-562907)*5%))

(441052)

December 31, 2021 net liability

$1996041

Asset at December 31, 2021 Initial balance, June 30, 2021

3000000

Accumulated depreciation at Dec. 31, 2021 (3000000/3*1/2)

(500000)

December 31, 2021

$2500000 PRETAX AMOUNT FOR RIGHT-OF-USE ASSET

3. What pretax amounts related to the lease would Georgia-Atlantic report in its income statement for the year ended December 31, 2021? Pretax amount $621855 June 30, 2021 interest  expense

0

Dec. 31, 2021 interest expense ((3000000-562907)*5%)

121855

Interest expense for 2021

121855 PRETAX AMOUNT FOR INTEREST EXP

Depreciation expense for 2021

500000 PRETAX AMOUNT FOR AMORTIZATION EXP

Total expenses

$621855

3a borrower  O  n January 1, 2021, Nath-Langstrom Services, Inc., a computer software training firm, leased several computers under a two-year operating lease agreement from ComputerWorld Leasing, which routinely finances equipment for other firms at an annual interest rate of 4%. The contract calls for four rent payments of $10,000 each, payable semiannually on June 30 and December 31 each year. The computers were acquired by ComputerWorld at a cost of $90,000 and were expected to have a useful life of five years with no residual value. Both firms record amortization and depreciation semiannually. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) ( Use appropriate factor(s) from the tables provided.) Required: Prepare appropriate journal entries recorded by Nath-Langstrom Services for the first year of the lease.

Nath-Langstrom Services, Inc. (Lessee): January 1, 2021 Lease payable ($10,000 × 3.80773Φ) = $38,077 Φpresent value of an ordinary annuity of $1: n = 4, i = 2% June 30, 2021 4% annually means 2% semiannually Interest expense (2% × $38,077) = $762 Amortization expense ($10,000 − $762) = $9,238

December 31, 2021 Interest expense (2% × [$38,077 − $9,238]) = $577 Amortization expense ($10,000 − $577) = $9,423

Note: In an operating lease, the lessee determines interest the normal way (at the effective interest rate) and then “plugs” the right-of-use asset amortization at the amount needed for interest plus amortization to equal the straight-line lease payment. The lessee reports that amount as a single lease expense in the income statement. Although ASC 842 doesn't specify this decomposition, the lessee must (a) calculate the interest component in order to determine the reduction of the lease payable over the lease term and (b) calculate the amortization component in order to determine the reduction in the balance of the right-of-use asset over the lease term. For convenience, we determine and record these two "components", and then combine them for purposes of reporting.

3a seller  LESSOR (seller) 2. Prepare appropriate journal entries recorded by ComputerWorld Leasing for the first year of the lease.

Computer World Leasing (Lessor): June 30, 2021 Depreciation expense ($90,000 ÷ 10 semi-annual periods) = $9,000 December 31, 2021 Depreciation expense ($90,000 ÷ 10 semi-annual periods) = $9,000

4 O  n January 1, 2021, Maywood Hydraulics leased drilling equipment from Aqua Leasing for a four-year period ending December 31, 2024, at which time possession of the leased asset will revert back to Aqua. The equipment cost Aqua $412,184 and has an expected economic life of five years. Aqua expects the residual value at December 31, 2024, to be $50,000. Negotiations led to Maywood guaranteeing a $70,000 residual value. Equal payments under the lease are $100,000 and are due on December 31 of each year with the first payment being made on December 31, 2021. Maywood is aware that Aqua used a 5% interest rate when calculating lease payments. (F  V of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

PV of 1: N=4, I=5% PVOA of $1: N=4, I=5% 70,000 guaranteed residual value minus 50,000 expected residual value

1. & 2. Prepare the appropriate entries for Maywood on Jan 1, 2021 and Dec 31, 2021, related to the lease.

RECORD ANNUAL PAYMENT OF THE LEASE.

4 M  id-South Auto Leasing leases vehicles to consumers. The attraction to customers is that the company can offer competitive prices due to volume buying and requires an interest rate implicit in the lease that is one percent below alternate methods of financing. On September 30, 2021, the company leased a delivery truck to a local florist, Anything Grows. The fiscal year for both companies ends December 31. The lease agreement specified quarterly payments of $3,000 beginning Sep 30, 2021, the beginning of the lease, and each quarter (December 31, March 31, and June 30) through June 30, 2024 (three-year lease term). The florist had the option to purchase the truck on Sep 29, 2023, for $6,000 when it was expected to have a residual value of $10,000. The estimated useful life of the truck is four years. Mid-South Auto Leasing’s quarterly interest rate for determining payments was 3% (approximately 12% annually). Mid-South paid $25,000 for the truck. Both companies use straight-line depreciation or amortization. Anything Grows’ incremental interest rate is 12%. Hint:  A lease term ends for accounting purposes when an option becomes exercisable if it’s expected to be exercised (i.e., a BPO). (F V of $1, PV  of $1, FVA  of $1, PVA  of $1, FVAD  of $1 and PVAD  of $1) 1. Calculate the amount of selling profit that Mid-South would recognize in this sales-type lease. (Be careful to note that, although payments occur on the last calendar day of each quarter, since the first payment was at the beginning of the lease, payments represent an annuity due.) $1,427

2. Prepare entries for Anything Grows and Mid-South on Sep 30, 2021.

3. Prepare an amortization schedule(s) describing the pattern of interest expense for Anything Grows and interest revenue for Mid-South Auto Leasing over the lease term.

4. Prepare entries for Anything Grows and Mid-South Auto Leasing on December 31, 2021. December 31, 2021 Anything Grows (Lessee) Amortization expense ([$26,427 ÷ 4 years*] × 1/4 year) = $1,652 Interest expense (3% × [$26,427 − 3,000] = $703 * Because title passes with the expected exercise of the BPO, depreciation is over the full 4-year useful life. Mid-South Auto Leasing (Lessor) Interest revenue (3% × [$26,427 − 3,000]) = $703

5. Prepare entries for Anything Grows and Mid-South Sep 29, 2023, purchase option exercised on that date. Anything Grows (Lessee) Amortization expense ([$26,427 ÷ 4 years*] × 1/4 year) = $1,652 Interest expense (3% × $5,826: sched) = $174 * Because title passes with the expected exercise of the BPO, depreciation is over the full 4-year useful life Mid-South Auto Leasing (Lessor) Interest revenue (3% × $5,826: from schedule) = $174...