Ayayai Corporation entered into a lease agreement on January 1, 2020, to provide Blossom Company with a piece of machinery. The terms of the lease agreement were as follows.
1. | The lease is to be for 3 years with rental payments of $13,936 to be made at the beginning of each year. | |
2. | The machinery has a fair value of $58,000, a book value of $40,000, and an economic life of 8 years. | |
3. | At the end of the lease term, both parties expect the machinery to have a residual value of $20,000, none of which is guaranteed. | |
4. | The lease does not transfer ownership at the end of the lease term, does not have a bargain purchase option, and the asset is not of a specialized nature. | |
5. | The implicit rate is 4%, which is known by Dawkins. | |
6. | Collectibility of the payments is probable. |
Evaluate the criteria for classification of the lease, and
describe the nature of the lease.
For the lessee, it is a
operating leasesales-type leasefinance
lease, and for the lessor, it is a
finance leasesales-type leaseoperating
lease.
Prepare the amortization schedules Blossom will use over the lease term.
BLOSSOM COMPANY Lease Amortization Schedule Annuity-Due Basis |
||||||||
Date | Annual Payment | Interest on Liability |
Reduction of Lease Liability |
Lease Liability | ||||
1/1/20 | $ | |||||||
1/1/20 | $ | $ | $ | |||||
1/1/21 | ||||||||
1/1/22 |
Lease Expense Schedule | ||||||||||||
Date | (A) Straight-Line Expense |
(B) Interest on Lease Liability |
(C) Amortization of Right-of-Use Asset (and Liability) (A-B) |
Carrying
Value of Right-of-Use Asset |
||||||||
1/1/20 | $ | |||||||||||
12/31/20 | $ | $ | $ | |||||||||
12/31/21 | ||||||||||||
12/31/22 |
Prepare the 2020 journal entries for Blossom.
Date |
Account Titles and Explanation |
Debit |
Credit |
Jan. 1 |
|||
(To record lease) |
|||
Jan. 1 |
|||
(To record first lease payment) |
|||
Dec. 31 |
|||
(To record lease expense and amortization) |
Prepare the 2020 journal entries for Ayayai.
Date |
Account Titles and Explanation |
Debit |
Credit |
Jan. 1 |
|||
(To record lease payments) |
|||
Dec. 31 |
|||
(To record lease revenue) |
|||
Dec. 31 |
|||
(To record depreciation) |
Suppose the lease were only for one year instead of 3 years, with just one lease payment at the beginning of the lease term. Prepare any journal entries Blossom would need, assuming it elects to use the short-term lease option.
Date |
Account Titles and Explanation |
Debit |
Credit |
Jan. 1 |
|||
A lease meeting any of the following 5 criteria is classified as financial lease | ||||||||
(a) Ownership is transferred at the end of the lease term | ||||||||
(b) A bargain purchase option for the leased asset exists | ||||||||
(c.) The lease term is primarily for the remaining economic life of the leased asset | ||||||||
(d) The present value of the lease payments and the residual value guarantees is | ||||||||
equal to or more than the fair value of the leased asset. | ||||||||
(e.) The leased asset has no altermnative use to the lessor at the end of its term | ||||||||
due to its specialized nature | ||||||||
Looking at the terms of the lease agreement between Ayayai Corporation and Blossom | ||||||||
Company, the lease would be classified as operating lease as it does not satisfy any of the | ||||||||
5 criteria stated above | ||||||||
Computation of Present Value of Lease Rentals | ||||||||
= P * (1-(1-r) ^-n)/r | ||||||||
where, P = Annual Lease Rent | ||||||||
r = rate of interest | ||||||||
n = period | ||||||||
Annual Lease Rental(P) | $13,936 | |||||||
Rate of interest (r.) | 4% | |||||||
Period (n) | 3 | |||||||
PV = P*(1-(1+r) ^-n)/r) | $38,674 | |||||||
Fair value of the lease asset = $ 38,674 | ||||||||
BLOSSOM COMPANY | ||||||||
Lease Amortization Schedule | ||||||||
Annuity- Due Basis | ||||||||
Date |
Annual Payment |
Interest on Liability |
Reduction of Lease Liability |
Lease Liability |
||||
1/1/2020 | $38,674 | |||||||
1/1/2020 | $13,936 | $1,547 | $12,389 | $26,285 | ||||
1/1/2021 | $13,936 | $1,051 | $12,885 | $13,400 | ||||
1/1/2022 | $13,936 | $536 | $13,400 | $0 | ||||
Lease expense schedule | ||||||||
Date |
Straight Line Expense |
Interest on Lease Liability |
Amortization of Right to use asset( and liability) (A-B) |
Carrying Value of Right to use asset |
||||
1/1/2020 | $38,674 | |||||||
1/1/2020 | $13,936 | $1,547 | $12,389 | $26,285 | ||||
1/1/2021 | $13,936 | $1,051 | $12,885 | $13,400 | ||||
1/1/2022 | $13,936 | $536 | $13,400 | $0 | ||||
Journal entries in the books of Blossom Corporation | ||||||||
Date | Account Title and Explanation | Debit | Credit | |||||
Jan-1 | Right of use Asset | $38,674 | ||||||
Lease Liability | $38,674 | |||||||
(To record lease) | ||||||||
Jan-1 | Lease Liability | $13,936 | ||||||
Cash | $13,936 | |||||||
(To record first lease payment) | ||||||||
Dec 31 | Lease Expense | $13,936 | ||||||
Lease Liability | $1,547 | |||||||
Right of use Asset | $12,389 | |||||||
(To record lease expense and amortization) | ||||||||
Journal entries in the books of Ayayai | ||||||||
Date | Account Title and Explanation | Debit | Credit | |||||
Jan-1 | Cash | $13,936 | ||||||
Lease Receivable Account | $13,936 | |||||||
(To record lease payment) | ||||||||
Jan-1 | Lease Receivable Account | $13,936 | ||||||
Lease Rental Income | $13,936 | |||||||
(To record lease revenue) | ||||||||
Dec 31 | Depreciation Expense | $5,000 | ||||||
Accumulated Depreciation - Leased Machinery | $5,000 | |||||||
(To record depreciation) | ||||||||
Note - Book value of asset in the books of Ayayai is $ 40,000 and
useful life is 8 years Depreciation = Book Value/Useful Life = $ 40,000/8 = $ 5,000 |
||||||||
In case of short term lease,the accounting for the lease is done in the same way as it is done in | ||||||||
Operating lease | ||||||||
The details of this short term lease would be as under | ||||||||
Annual Lease Rental(P) | $13,936 |
where, P = Annual Lease Rent r = rate of interest n = period |
||||||
Rate of interest (r.) | 4% | |||||||
Period (n) | 1 | |||||||
PV = P*(1-(1+r) ^-n)/r) | $13,400 | |||||||
Fair Value of the asset = $ 13,400 | ||||||||
Journal entries in the books of Blossom Corporation | ||||||||
Date | Account Title and Explanation | Debit | Credit | |||||
Jan-1 | Right of use Asset | $13,400 | ||||||
Lease Liability | $13,400 | |||||||
(To record lease) | ||||||||
Jan-1 | Lease Liability | $13,936 | ||||||
Cash | $13,936 | |||||||
(To record first lease payment) | ||||||||
Dec 31 | Lease Expense | $13,936 | ||||||
Lease Liability | $536 | |||||||
Right of use Asset | $13,400 | |||||||
(To record lease expense and amortization) |
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