Question

On January 1, 2017, Galactus Corp. (lessor) entered into a noncancellable lease agreement with Blade Corp. (lessee) for machinery which was carried in Galactus’s accounting records at $2,265,000 and had a fair value of $2,400,000. Minimum lease payments under the lease agreement, which expires on December 31, 2026, total $3,550,000. Payments of $355,000 are due each January 1. The first payment was made on January 1, 2017 when the lease agreement was finalized. The interest rate of 10% which was stipulated in the lease agreement is the implicit rate set by the lessor. The effective interest method is being used. Blade expects the machine to have a ten-year life with no residual value, and be depreciated on a straight-line basis. Collectability of the rentals is reasonably assured, and there are no important uncertainties surrounding the costs yet to be incurred by Galactus. Both entities are small private corporations that follow ASPE.

Instructions

a.   From the lessee's viewpoint, what kind of lease is the above agreement? From the lessor's viewpoint, what kind of lease is the above agreement?

b.   Ignoring income taxes, what should be the income reported by Galactus from the lease for calendar 2017?

c.   Ignoring income taxes, what should be the expenses incurred by Blade from this lease for the calendar 2017?

d.   What journal entries should be recorded by Blade Corp. on January 1, 2017?

e.   What journal entries should be recorded by Galactus Corp. on January 1, 2017?

Answer 1

a)

   The estimated useful life is around 10 years and the lease period is also around 10 years, hence, the asset is being used subretinal by the lease, also, all the risks and rewards incidental to such asset is automatically to the lesse.

Also, the sum of the present value of the minimum lease payment is approximately equal to the fair value of the asset.

Hence, the said agreement is a Finance Lease.

b)

Finance Income to be reported by Garfield in Calendar 2017 shall be as follows:

Garfield shall record this transaction at Net Investment Value, which shall be equal to $ 24,00,000 (Gross Investment Value(GIL) - [(GIL)-Present Value of Minimum Lease payment (MLP)]

We calculate the present value of MLP at a rate of 10% as follows:

Period	Annual Lease Payment	PV Factor	Present Value
0	355000	1	355000
1	355000	0.9091	322727
2	355000	0.8264	293388
3	355000	0.7513	266717
4	355000	0.6830	242470
5	355000	0.6209	220427
6	355000	0.5645	200388
7	355000	0.5132	182171
8	355000	0.4665	165610
9	355000	0.4241	150555
Grand Total			2400000

Total Income for Calendar 2014 = ($ 355,000 - $355,000) + ($ 355,000 - $322,727) = $ 32273 shall be recognized as Finance Income.

C)

Expense incurred by Odie :

Particulars	Amount ($)
Depreciation (2400000/10)	240,000
Finance expense (355000-322727)	32,273
Total	272,273

Date	Particulars	Debit ($)	Credit ($)
i)	Asset	2,400,000
	Garfield Corp		2,400,000
ii)	Garfield Corp	355,000
	Bank		355,000

e)

Date	Particulars	Debit ($)	Credit ($)
	Odie Corp	2,400,000
	Assets		2,265,000
	Other Equity		135,000
	Bank	355,000
	Odie Corp		355,000

Note: No entry for recognizing Finance income and expense has been passed as the entry is passed on 1st Jan 2017 and there is no time gap, accordingly no period has elapsed.