Question

E21.13 (LO 2,4) (Lessee-Lessor Entries, Sales-Type Lease; Guaranteed Residual Value) Phelps Company leases a building to Walsh, Inc. on January 1, 2020. The following facts pertain to the lease agreement. 1. The lease term is 5 years, with equal annual rental payments of $4,703 at the beginning of each year. 2. Ownership does not transfer at the end of the lease term, there is no bargain purchase option, and the asset is not of a specialized nature. 3. The building has a fair value of $23,000, a book value to Phelps of $16,000, and a useful life of 6 years. 4. At the end of the lease term, Phelps and Walsh expect there to be an unguaranteed residual value of $4,000 5. Phelps wants to earn a return of 8% on the lease, and collectibility of the payments is probable. This rate is known by Walsh. Instructions a. How would Phelps (lessor) and Walsh (lessee) classify this lease? How would Phelps initially measure the lease receivable, and how would Walsh initially measure the lease liability and right-of-use asset? b. Using the original facts of the lease, show the journal entries to be made by both Phelps and Walsh in 2020. c. Suppose the entire expected residual value of $4,000 is guaranteed by Walsh. How will this change your answer to part a? d. Assume the same facts as part c, except the expected residual value is $3,000. Does your answer change?

Answer 1

a) IPhelps and Walsh would reassify this as a capital lease because of the following conditions fulfilled A lease is said to be a capital lease when she or more conditions are met: The ownership of property transfers to lessee at the end of lease period. 2) Lease contains bargain purchase option s a - 3 Lease term is at least 75% of estimated economic ije. 4 Present value of the minimum lease payments is at least 1 gol of the excess of fair value of leased property. Here, condition 3 has been fulfilled. Therefore, it is a capital Mase I Calculation of rease by Phelps and Walsh year Mininn Lease payment PUF @ 8% R of cash flows 0.925 0.8 57 RANDT 0.793 $4703 $ 4703 $ 4703 $4703 $ 4703 $23,515 $4350 28 $4030.47 $ 3+29:48 $ 34 56.71 $3198.06 0 0.735 0. 680 Total (A) $18, +64.97 & unguaranteed Residual value $4000 0-680 $ 2720 $27,515 $ 21,484.97

are receivable in recorded by Phelps shown un lease payments (A + unguaranteed residual = $ 21,484 = Minimum lease payments (A) varme (B) Ish asset should record the lease liability & right of use in rease payments & Guarantee value = $ 18, 764.97 Cassets and liability = Minimum pase payments t be) Journal entries Date 11220 I particulars In the books of Phelps Lease receivable from Walsh - To Assets (To record lease receivables) $ 21,484 21,484 $218764 In the books of Walsh Wasets - To lease liability (to record assets and liability) $18764 34/12/ 20 $ 3,722 Depreciation 1 Тоолло (Being depreciation recorded) $3752

(ic) Residual value of $4000 is now gurauteed by hero Walsh. Lease aceivable recorded by Phelps. - $ 18764 Lease liability and resets recorded by Walsh = $18764 + $0720 = $ 21,484 po ints (and vd) y the expected Resi dial value is $3000 guaranteed), then Lease receivable recorded by Phelps = $18,764 Lease Liability and assets accorded by Waldi = $ 18764 +($ 3000X0.630) del $ 0,804 la
The above answer has provided you with the relevant theory on capital lease as well. It's a comprehensive and to the point answer.