Question

On 1 January 20X2, Supergrocery Inc. sold its major distribution facility, with a 22-year remaining life, to a real estate investment trust (REIT) for $9,006,000 cash, its estimated fair value. The facility had an original cost of $9,907,000 and accumulated depreciation of $2,972,100 on the date of sale.

Also on 1 January 20X2, Supergrocery signed a 20-year lease agreement with the REIT, leasing the property back. Annual payments, beginning on 31 December 20X2, are $835,200. Supergrocery has an incremental borrowing rate of 8%. The company uses straight-line depreciation and has a 31 December year-end. Supergrocery records a part-year’s depreciation on buildings, based on the date of acquisition. There is an expected residual value at the end of the lease term of $64,000 but this amount is not guaranteed. Round to the nearest percentage. (Do not round intermediate calculations. Round final answers to the nearest whole dollar amount.)

(PV of $1, PVA of $1, and PVAD of $1.) (Use appropriate factor(s) from the tables provided.)

Required:
1. Give the 20X2 entries that Supergrocery would make to record the sale and the lease. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Record the lease for the major distribution facility under a sale-leaseback.

Record the interest expense for the period ending December 31, 20X2.

Record the depreciation expense on leased distribution facility for the period ending December 31, 20X2.

Answer 1

Sale and Lease Back Transactions 1. The Given Sale and Lease Back Transaction is in the nature of Finance Lease since the period of lease covers substantially the life of the property. 2. The Profit on Sale of Property is caleulated as follows: Aount (in $) 9,907,000 2,972,100 6,934,900 9,006,000 Particulars 1. Cost 2. Less: Accumulated Depreciation 3. Book Value (1-2) 4. Sale Value 5. Profit (4-3) 2,071,100 Note: This Profit shall not be recognized in the books immediately, but deferred over the lease period (20 Years) using an appropriate menthod. In this case the annual income to be recognized would be $1,03,550 on straight line basis because depreciation is also recognized on straight line basis

3. The Fair Value of the Property is given ($9,006,000) Therefore the Property shall be recorded by the Lessee at this value Statement showing Repayment Schedule and Interest Expense for the Year 2012 Total Opening Balance Interest at 8% 3 (2 8%) Lease Payment Closing Balance Year 1 2. 4 2+3 5 6 4-5 2012 $ 9,006,000 $ 720,480 $ 835,200 $ 9,726,480 $ 8,891,280 Statement Showing Annual Depreciation and closing balance of the Property Closing Annual Useful Life Year Opening Balance Depreciations 4 2/3 Balance 1 2. 3 5 2-4 2012 $ 20.00 $ 450,300 $ 8,555,700 9,006,000

Journal Entries in the books of Supergrocery Inc Entry Credit Date Debit 1.1.2012 Bank A/c Dr $ 9,006,000 2,972,100 S Accumulated Depreciation A/c Dr$ To Property A/c 9,907,000 To Deferred Income A/c S 2,071,100 Being Sale Entry of Property Recorded) 1.1.2012 Property A/c Dr $ 9,006,000 9,006,000 (Being Property acquired on Finance Lease recorded at its Fair Value) To Pavable to REIT A/c 31.12.2012 Interest Expense A/c Dr $ 720,480 $ To Payable to REIT A/c 720,480 Being Interest Expense for the recognized) year on account finance lease is 31.12.2012 Payable to REIT A/c Dr $ 835,200 To Bank A/c 835,200 (Being Annual Lease Payment made)

31.12.2012 Depreciation A/c D 450,300 $ To Accumulated Depreciation A/c Being Depreciation for the year is recognized) 450,300 |31.12.2012 Deferred Income A/c Dr $ 103,555 $ To Profit on Sale of Property A/c 103,555 Being Profit on sale of Property is recognized on straight line basis ) |31.12.2012 Profit & Loss A/c Dr $ 1,067,225 103,555 $ Profit on Sale of Property A/c Dr To Depreciation A/c To Interest Expense A/c Being all items having an effect on Profit & Loss Statement transferred $ 450,300 720,480 $ to P&L A/c)

In the given question fair value is given. Therefore the asset is recorded at its fair value. As a result there is no requirement to find the Present Value of annual lease payments.