Question

Lanier Dairy Ltd. leases its milk cooling equipment from Green Finance Corporation. Both companies use IFRS 16. The lease has the following terms.
1. The lease is dated May 30, 2017, with a lease term of eight years. It is non-cancellable and requires equal rental payments of $30,000 due each May 30, beginning in 2017.
2. The equipment has a fair value and cost at the inception of the lease of $211,902, an estimated economic life of 10 years, and a residual value (which is guaranteed by Lanier Dairy) of $23,000.
3. The lease contains no renewal options and the equipment reverts to Green Finance Corporation on termination of the lease.
4. Lanier Dairy's incremental borrowing rate is 6% per year; the implicit rate is also 6%.
5. Lanier Dairy uses straight-line depreciation for similar equipment that it owns.
6. The collectibility of the payments is reasonably predictable, and there are no important uncertainties about costs that have not yet been incurred by the lessor.
Instructions

(a) Describe the nature of the lease and, in general, discuss how the lessee and lessor should account for the lease transaction.

(b) Using tables, a financial calculator, or Excel functions, calculate the present value of the lease payments and guaranteed residual value under the lease.

(c) Prepare the journal entries for the lessee and lessor at May 30, 2017 and at December 31, 2017, which is the lessee's and lessor's year ends.

(d) Prepare the journal entries at May 30, 2018 for the lessee and lessor. Assume reversing entries are not used.

(e) What amount would have been capitalized by the lessee upon inception of the lease if:
1. The residual value of $23,000 had been guaranteed by a third party, not the lessee?
2. The residual value of $23,000 had not been guaranteed at all?

(f) On the lessor's books, what amount would be recorded as the net investment at the inception of the lease, assuming:
1. Green Finance had incurred $1,200 of direct costs in processing the lease?
2. The residual value of $23,000 had been guaranteed by a third party?
3. The residual value of $23,000 had not been guaranteed at all?

(g) Assume that the milk cooling equipment's useful life is 20 years. How large would the residual value have to be at the end of eight years in order for the lessee to qualify for the operating method? Assume that the residual value would be guaranteed by a third party.

(h) Discuss how Lanier would have determined the classification of the lease if the company were using ASPE for its financial reporting.

Answer 1

(a) Describe the nature of the lease and, in general, discuss how the lessee and lessor should account for the lease transaction.

(b) Using tables, a financial calculator, or Excel functions, calculate the present value of the lease payments and guaranteed residual value under the lease.

(c) Prepare the journal entries for the lessee and lessor at May 30, 2017 and at December 31, 2017, which is the lessee's and lessor's year ends.

(d) Prepare the journal entries at May 30, 2018 for the lessee and lessor. Assume reversing entries are not used.

(e) What amount would have been capitalized by the lessee upon inception of the lease if:
1. The residual value of $23,000 had been guaranteed by a third party, not the lessee?
2. The residual value of $23,000 had not been guaranteed at all?

(f) On the lessor's books, what amount would be recorded as the net investment at the inception of the lease, assuming:
1. Green Finance had incurred $1,200 of direct costs in processing the lease?
2. The residual value of $23,000 had been guaranteed by a third party?
3. The residual value of $23,000 had not been guaranteed at all?

(g) Assume that the milk cooling equipment's useful life is 20 years. How large would the residual value have to be at the end of eight years in order for the lessee to qualify for the operating method? Assume that the residual value would be guaranteed by a third party.

(h) Discuss how Lanier would have determined the classification of the lease if the company were using ASPE for its financial reporting.

Refer the below images for the above asked questions, in a detailed way of solution with explanation.

Revurement a x @ Green Finance Corporation, the lesson, needs to determine that the risks & benefits of ownership of the leased property are transferred . These factors include: - There is reasonable assurance that the lessee will Obtain ownership of the leased property by the en of the lease term. If there is a porchase option in the lease, Green needs to determine that it is reasonably the purchase Option will be exercised by the lessee - The lease term is long enough that the lessee will receive substantially all of the economic benefits that are expected to be derived from using the leased property over its life. This Criteria appears to have been met since the lease is for 8 years cusoan eta life of 10 years). - The lease allows the of all its investment in earn a return on the provided if the present payments is close to asset. lessor to recover substantially the leased Property and to investment Evidence of this is Value of the minimum rea the fair value of the leased - The mggor they are leased assets are so specialized modification and significant cost of use only to the lessee. that without to the lessor * In this case, Dairy td. as a under IFRS 16 a Short-term the lease would be set up by Lanier right of use asset and lease liability as the rease does not quality for cor low-value exemption lease.

$ 30000 X 6.58238* $ 23000 x 0.62741** $ 197471.40 443043 - Revoivendent pov-of minimom lease payments to 3 lease payments & 2 11901.83 * * * p.v. pv. factor factor of of annuity due at $1 at 6-1 for 6to for 8 years 8 years. - May 30, 2017 Requirement Lessee Credit Debit $24902 or * Right of use Asset Alc To lease liability 211902 * or Lease liability All To cash Ale 530000 130000 $ 30000 130000 May 30, 2017 Lessor: $ 263000 Lease Receivable To enjuipment To unearned Alc or Acosuired Interest for lessee Income $ 211902 $51098 Working @ : $263000 = 8x$30000 + $ 23000 (residual value) Cash $30000 Alc To lease Receivable $30000

December 31, 2017 Debit (vedit 16367 Less୯୧ * Interest expense ale or 5 6367 9o Interest payable Worrning: Cal- of interest [(4211902 - 190000)x •0647] & $13774 Depreciation expense ale or {13774 TO Accemulated Dep-Right of use Asset Working: cal of Depreciation [(8211902 - $ 23000) = 8 x 7 ] December 31, 2017 Lessor: Alc or $6367 Unearned TO interest Interest income income $6367 May 30, 2018 Reasurement Co Lessee ! * & 19086 4542 Lease Interest Interest liability All expense All payable Alc To cash ale or Dr DV 6367 $30000 working : [(1 2490 2-1 30000) * • 06 XF ]

credit ressor: x Debit $4547 Unearned - TO interest Interest income All or income $4547 $ 30000 cash - Al Dr To lease Receivable $ 30000 Lont : (1) & (2) are both no obligation to pay $ 197471, as the lessee has the residual value - Reativement : Live Regjoirchent In the case co the amount of net investment at the inception of the lease would be $211902 + $12.00 Cor) 9 213102 . For (2) & (3) both would be $211902 , as the estimated residual value exists whether or not it is gooranteed. : Realuirement @: The present value of the residual would have to be at least 10% of the four value of the leased asset con 101-4 $211962 = $ 21190.20. The future value of this lomp som (n=8, 1=6) = $21190.204 1.59385 (or) $2490.208.62741, both of which = $33774

Lent Realuirement : Had Green been using ASPE: The lease agreement Satisfies both the 7540 and 901 aquantitative requirements, Collectability is reasonably predictable and there are no important uncertainties surrounding the costs yet to be incorred by the dessora For Lanier Dairy Ltd., the lessee, it is a capital lease, and for Green Finance corporation, the lesson, it is a direct financing lease (since cost equals fair value).