Question

Problem 3: The following facts pertain to a non-cancelable lease agreement between Lessee and Lessor: Date of the lease 12/31/YO Annual lease payment Payment 1 due immediately) $20,472 Bargain Purchase Option (lessee expects to exercise) $4,000 Lease Term 5 years Economic Life of Leased Asset 10 years Lessor's Cost of the asset $65,000 Fair Value of the asset $91.000 Lessor's Implicit Rate & Lessee's Incremental Borrowing Rate The collectability of the lease payments by Lessor is probable. A. For the lessee, is the lease a finance lease or an operating lease? Explain why or why not. B. Prepare the lessee's journal entries through 12-31-Yr2.

Answer 1

Lease Payment Present Value A Year DR @ 8% 12/31/Yro 12/31/Yr1 12/31/Yr2 12/31/Yr3 1.00000 20,472 20,472 20,472 18,956 0.92593 20,472 0.85734 17,551 20,472 0.79383 16,251 12/31/Yr4 20,472 0.73503 15,048 12/31/Yr5 2,722 4,000 0.68058 Total 91,000 As we can see, present value of all the lease rentals paid plus present value of For Lessee, It is a Financial Lease A lease is normally classified as a finance lease if any of the following conditions apply: 1) The asset transfers to the lessee at the end of the lease term 2) The lessee has an option to purchase the asset from the lessor at below fair value 3) The lease term is for a significant part of the asset's useful economic life 4) The present value of future lease payments amounts to substantially all of the asset's fair value 5) The leased asset is specialised in nature If any of the above condition satisfied, it can normally be said that the lease transfers substantially all the risks and rewards of ownership to the lessee. Effective Interest Table Opening Balance Interest@8% Instalment Year 12/31/Yro Closing Balance 91,000 20,472 70,528 12/31/Yr1 12/31/Yr2 12/31/Yr3 55,698 70,528 5,642 20,472 20,472 39,682 55,698 4,456 39,682 3,175 20,472 22,385 12/31/Yr4 22,385 1,791 20,472 3,704 12/31/Yr5 296 3,704 4,000 Lessee's Journal Entries through 12-31-Yr2 В Credit Particulars Date Debit Finance Charges/Interest Expenes To Lease Liability (To record interest expense) 4,456 Dec 31,Y2 4,456 Lease Liability To Bank/Cash 20,472 Dec 31,Y2 20,472 (To record lease payment) Amortiation Expense 18,200 Dec 31,Y2 To Asset on Lease 18,200 To record amortization of the right-of-use asset) What Accounts & Balances will be shown on the classified Balance Sheet & Multistep Income C Statement at 12-31-Year1? Name of Account Asset on Lease Lease Liability Lease Liability Amortisation Expense Interest Expenses Support of Calculations =91000-18200 Balance Financial Statement Account Classification Balance Sheet Balance Sheet Non-Current Assets Non-Current Liabilities - Lease Liability Current Liabilities -Short Term Lease Liability 20472-4456 72,800 Year 2 Closing Balance (see Amotisation Table) 39,682 16,016 Balance Sheet - 91000/5 Year 1 Interest Charges (see Amotisation Table) Depreciation & Amortisation Finance Charges 18,200 Income Statement 5,642 Income Statement