Question

Grouper Corporation leased equipment to Skysong, Inc. on January 1, 2017. The lease agreement called for annual rental payments of $1,205 at the beginning of each year of the 3-year lease. The equipment has an economic useful life of 7 years, a fair value of $8,200, a book value of $6,200, and Grouper expects a residual value of $5,700 at the end of the lease term. Grouper set the lease payments with the intent of earning a 6% return, though Skysong is unaware of the rate implicit in the lease and has an incremental borrowing rate of 8%. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature. Click here to view the factor table. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Determine the nature of the lease to both Grouper and Skysong. The lease is a/an lease to Skysong. The lease is a/an lease to Grouper.

Answer 1

Part 1

The lease is an operating lease to Skysong

The lease is an operating lease to Grouper

The lease term is only 43% (3 ÷ 7) which is less than 75% of the economic life of the asset.

No bargain purchase, no transfer of ownership

Asset is not specialized

The present value of periodic rental for lessor $3414 (1205*2.83339) and the present of value of periodic rental for lessee $3354 (1205*2.78326) do not meet test of 90% of fair value

P V of annuity due of 1 for n = 3, i = 6% is 2.83339

PV of annuity due of 1 for n = 3, i = 8% is 2.78326

Part 2

Date	Account Titles and Explanation	Debit	Credit
1/1/17	Right-of-Use Asset	3354
	Lease Liability		3354
	(To record the lease)
1/1/17	Lease Liability	1205
	Cash		1205
	(To record lease liability)
12/31/17	Lease Expense	1205
	Lease Liability ((3354-1205)*8%)		172
	Right-of-Use Asset (balancing figure)		1033

Part 3

Lease liability

PV of annual rental payment	3354
PV of insurance payments ($200 X 2.78326)	557
Lease liability	$3911

Right-of-use asset

Initial measurement of lease liability	3911
Commissions paid	500
Prepaid rent	700
Right-of-use asset	$5111

Part 4

Date	Account Titles and Explanation	Debit	Credit
1/1/17	Lease expense	1205
	Cash		1205