Question

Salaur Company, a risky start-up, is evaluating a lease arrangement being offered by TSP Company for use of a standard computer system. The lease is non-cancelable, and in no case does Salaur receive title to the computers during or at the end of the lease term. TSP will lease the returned computers to other customers. The lease starts on January 1, 2020, with the first rental payment due on January 1, 2020. Additional information related to the lease and the underlying leased asset is as follows.

Yearly rental	$3,057.25
Lease term	3 years
Estimated economic life	5 years
Purchase option	$3,000 at end of 3 years, which approximates fair value
Renewal option	1 year at $1,500; no penalty for nonrenewal; standard renewal clause
Fair value at commencement	$10,000
Cost of asset to lessor	$8,000
Residual value:
Guaranteed	–0–
Unguaranteed	$3,000
Lessor's implicit rate (known by the lessee)	12%
Estimated fair value at end of lease	$3,000

Accounting

a.   

Analyze the lease classification tests for this lease for Salaur. Prepare the journal entries for Salaur for 2020.

b.   

Repeat the requirements in part a, assuming Salaur has the option to purchase the system at the end of the lease for $100.

Answer 1

Answer is given below

A Lease is a Finance Lease if any of the following conditions is fulfilled a) - The asset must be transferred to the lessee at the end of the term b) - The lessee has an option to purchase the asset at the end of the term below its fair value c) - The lease term covers the significant period of the asset's useful life (at least 75% or more) e) - The present value of future lease payments covers the substantial part of asset cost (at least 90%) f) - The leased asserts is of specialised nature and suits the needs of lessee only Applying above conditions a) This criteria is not met b) Purchase is at fair value at end of the lease term. Hence not a capital lease c) Lease term is 3 years Economic life of asset is 5 years So it is 60% of total life of asset. Hence criteria is not met d) Calculation of present value of lease payments Lease PV factor PV of Lease Year Amount at 12% payments Total $3,057.25 2.6901| $8,224.16 Fair value at the inception of the lease PV of lease payment as % of fair value $10,000 82% Since the PV of lease payment is 82% criteria is not met (threshold is 90%) e) Asset is not of specialized nature. Hence criteria is not met Therefore the lease is accounted as operating Lease

ACCOUN Credit Journal Entries - Salaur Books Date Account Titles and Explanation 01.01.2020 Rent Expense To Cash (Being payment of lease rental) Debit $3,057.25 $3,057.25

Since Asset can be purchased below its fair value at the end of the term The lease will be treated as Finance lease Fair value is $3,000 Purchase value $100 Bargain Purchase price significantly below fair value will be treated as Capital lease Lease Year Amount Lease payments $3,057.25 Purchase price $100.00 Total Minimum lease payments PV factor PV of Lease at 12% payments 2.6901 $8,224.16 0.7972 $79.72 $8,303.88 |Fair value at the inception of the lease $10,000| Assets will recorded at lower of above 2 Present value of minimum lease payment $8,303.88| Reduction Date Annual Lease Payment Interest at 12% of Lease Liability Liability $0 01.01.2020 01.01.2021 01.01.2022 $8,304 $5,247 $2,819 $100 $3,057 $3,057 $3,057 $2,428 $2,719 $630 $338

Credit Debit $8,304 $8,304 $3,057 $3,057 Date Account Titles and Explanation 01.01.2020 Right-to-use Asset To Lease Liability (Being lease recorded) 01.01.2020 Lease Liability To Cash (Being lease liability paid) 31.12.2020 Interest Expense To Interest payable (Being Interest payable recorded) 31.12.2020 Depreciation To Right-to-use Asset (Being amortisation of the Right-to-use Asset) $630 $630 $2,768 $2,768