Question

Check 4. On December 31, 2021, Yard Art Landscaping leased a delivery truck from Branch Motors. Branch paid $40,000 for the truck. Its retail value is $45.114. 2 points The lease agreement specified annual payments of $11,000 beginning December 31, 2021, the beginning of the lease, and at each December 31 through 2024. Branch Motors' interest rate for determining payments was 10%. At the end of the four-year lease term (December 31, 2025) the truck was expected to be worth $15,000. The estimated useful life of the truck is five years with no salvage value. Both companies use straight-line amortization or depreciation eBook Print References Yard Art guaranteed a residual value of $6,000. Yard Art's incremental borrowing rate is 9% and is unaware of Branch's implicit rate. A $1,000 per year maintenance agreement was arranged for the truck with an outside service firm. As an expedient, Branch Motors agreed to pay this fee. It is, however, reflected in the $11,000 lease payments. (FV of $1. PV of $1. FVA of $1. PVA of $1. EVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. How should this lease be classified by Yard Art Landscaping (the lessee)? 2. Calculate the amount Yard Art Landscaping would record as a right of-use asset and a lease liability. 3. How should this lease be classified by Branch Motors (the lesson)? 4. Show how Branch Motors calculated the $11,000 annual lease payments. 5. Calculate the amount Branch Motors would record as sales revenue. 6. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2021. 7. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Yard Art. 8. Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Branch Motors. 9. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2022 10. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2024 (the final lease payment). 11. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2025 (the end of the lease term), assuming the truck is returned to the lessor and the actual residual value of the truck was $4,000 on that date. < Prev 4 of 6 Next >

Answer 1

Requirement 1

Since at least one (exactly one in this case) criterion is met, this is a finance lease to the lessee:

Lessee’s Application of Classification Criteria

   1   Does the agreement specify that
     ownership of the asset transfers
     to the lessee?                                                                         NO

2   Does the agreement contain a
     bargain purchase option?                                                       NO

3   Does the lease term constitute                                              YES
     the major part of the expected            {lease term 4 yrs. ; useful life 5 yrs.}
    economic life of the asset?                                                       

   4   Is the present value of the
     lease payments greater than or                                          YES or NO
     equal to substantially all of the                       {$39,564a ; $45,114 }

        fair value of the asset?                                               present        fair
                                                                                            value        value

5     Is the asset is of such a specialized

        nature that it is expected to haveno

        alternative use to the lessor at the

        end of the lease term?                                                          NO

a([$11,000 – 1,000] x 3.53129* +($6,000x .70843**) = $39,564

          ** present value of an annuity due of $1: n=4, i=9%

          *   present value of $1: n=4, i=9%

Note: The lessee uses its incremental borrowing rate (9%) because it is unaware of the lessor’s implicit rate (10%)

Requirement 2

      Present value of lessee’s periodic payments (not including residual value):       

([$11,000 – 1,000] x 3.53129**) = $35,313

            ** present value of an annuity due of $1: n=4, i=9%

Requirement 3

Since at least one classification criterion is met, this is a sales-type lease to the lessor.

Lessor’s Application of Classification Criteria

   1   Does the agreement specify that
     ownership of the asset transfers
     to the lessee?                                                                         NO

2   Does the agreement contain a
     bargain purchase option?                                                       NO

3   Does the lease termconstitute                                               YES
     the major part of the expected            {lease term 4 yrs. ; useful life 5 yrs.}
    economic life of the asset?                                                       

4      Is the present value of the
     lease payments greater than or                                              NO
     equal to substantially all of the                       {$38,967a ; $45,114 }

        fair value of the asset?                                               present        fair
                                                                                            value        value

5     Is the asset is of such a specialized

        nature that it is expected to haveno

        alternative use to the lessor at the

        end of the lease term?                                                          NO

a([$11,000 – 1,000] x 3.48685*+($6,000x .68301**) = $38,967

          ** present value of an annuity due of $1: n=4, i=10%

          *   present value of $1: n=4, i=10%

Requirement 4

Lessor’s Calculation of Lease Payments

   Amount to be recovered (fair value)                                                                    $45,114

   Less: Present value of the residual value ($15,000 x .68301*)                            (10,245)

   Amount to be recovered through periodic lease payments                                  $34,869

                                                        ________________________________________½

   Lease payments at the beginning½

      of each of the next four years:          ($34,869 ÷ 3.48685**)                           $10,000

   Plus: Maintenance costs                                                                                           1,000

   Lease payments including maintenance costs $11,000

                                 *    present value of $1: n=4, i=10%

                                 ** present value of an annuity due of $1: n=4, i=10%

Requirement 5

Lessor’s Calculation of the Sales Revenue

   Present value of periodic payments ([$11,000 – 1,000] x 3.53129**)                $34,869

   Plus: Present value of the lessee-guaranteed                                                                   

             residual value ($6,000*** x .68301*)                                                            4,908

   Sales revenue                                                                                                       $38,967

    *       present value of $1: n=4, i=10%

    **     present value of an annuity due of $1: n=4, i=10%

    Or, equivalently:

   Fair value                                                                                                             $45,114

   Minus: Present value of the unguaranteed                                                                       

             residual value ($9,000*** x .68301*)                                                            4,908

   Sales revenue                                                                                                       $38,967

* This is the unguaranteed residual value: $15,000 – 6,000

     

Since the “selling price” (present value of the lease receivable) exceeds the lessor’s book value, the asset is being “sold” at a profit, making this a sales-type lease:

                   Sales revenue                                          $38,967 (Calculated above)

                       Minus                                                                          

                   Cost of goods sold                                  (33,853) ($40,000 – [$9,000* x .68301])

                       equals

                   Selling profit                                            $ 5,114

* This is the unguaranteed residual value: $15,000 – 6,000.  Alternatively, since the fair value exceeds the lessor’s book value, the selling profit can also be calculated as:

                   Fair value                                                $45,114

                       minus

                   Book value                                              (40,000)

                       equals

                   Selling profit                                            $ 5,114

Requirement 6

December 31, 2021

Yard Art Landscaping (Lessee)
Right-of-use asset (calculated in requirement 2)...........................               35,313
     Lease payable (calculated requirement 2).................................                                      35,313

Lease payable (payment less maintenance costs)..........................               10,000
Prepaid maintenance expense (2019 fee)......................................                 1,000
     Cash (lease payment)................................................................                                      11,000

Branch Motors (Lessor)
Lease receivable (to balance).........................................................               45,114
Cost of goods sold ($40,000 – [$9,000a x .68301])......................               33,853
     Sales revenue ($45,114 – [$9,000a x .68301])..........................                                      38,967

Equipment (lessor’s cost)...............................................................                                      40,000

Cash (lease payment).....................................................................               11,000
     Maintenance fee payable [or prepaid maintenance*]................                                        1,000
     Lease receivable (payment less maintenance costs)..................                                      10,000

aThis is the unguaranteed residual value: $15,000 – 6,000.

* If paid previously.

Requirement 7

Lessee’s Amortization Schedule

                                                     Effective                      Decrease                  Outstanding
  Dec.       Payments                    Interest                      in Balance                    Balance
    31                               9% x Outstanding Balance

                                                                                                                            35,313

2021 10,000                                                             10,000 5,313

2022 10,000         .09  (25,313)  =   2,278                  7,722                     17,591

2023 10,000         .09  (17,591)  =   1,583                  8,417                       9,174

2024   10,000         .09    (9,174)  =      826                  9,174                              0

                    40,000                                    4,687                35,313

Requirement 8

Lessor’s Amortization Schedule

                                                     Effective                      Decrease                  Outstanding
  Dec.       Payments                    Interest                      in Balance                    Balance
    31                              10% x Outstanding Balance

                                                                                                                               45,114

2021 10,000                                                             10,000                        35,114

2022 10,000         .10  (35,114)  =   3,511                  6,489                        28,625

2023 10,000         .10  (28,625)  =   2,863                  7,137                        21,488

2024 10,000         .10  (21,488)  =   2,149                  7,851                        13,637

2025   15,000         .10  (13,637)  =   1,363*              13,637                                 0

                    55,000                                    9,886                45,114

                      * adjusted for rounding of other numbers in the schedule

Requirement 9

December 31, 2022

Yard Art Landscaping (Lessee)
Maintenance expense (2022 fee)...................................................                 1,000
     Prepaid maintenance expense (paid in 2021)............................                                        1,000

Interest expense (9% x [$35,313 – 10,000])..................................                 2,278
Lease payable (difference)............................................................                 7,722
Prepaid maintenance expense (2020 fee)......................................                 1,000
     Cash (lease payment)................................................................                                      11,000

Amortization expense ($35,313 ÷ 4 years)....................................                 8,828
     Right-of-use asset.....................................................................                                        8,828

Branch Motors (Lessor)
Cash (lease payment).....................................................................               11,000
     Maintenance fee payable [or prepaid maintenance*]................                                        1,000
     Lease receivable (payment less maintenance costs)..................                                        6,489

Interest revenue (10% x [$45,114 – 10,000])................................                                        3,511

* If paid previously.

Requirement 10

December 31, 2024

Yard Art Landscaping (Lessee)
Maintenance expense (2024 fee)...................................................                 1,000
     Prepaid maintenance expense (paid in 2023)............................                                        1,000

Interest expense (9% x $9,174: from schedule)............................                    826
Lease payable (difference: from schedule)....................................                 9,174
Prepaid maintenance expense (2025 fee)......................................                 1,000
     Cash (lease payment)................................................................                                      11,000

Amortization expense ($35,313 ÷ 4 years)....................................                 8,828
     Right-of-use asset.....................................................................                                        8,828

Branch Motors (Lessor)
Cash (lease payment).....................................................................               11,000
     Maintenance fee payable [or prepaid maintenance*]................                                        1,000
     Lease receivable (payment less maintenance costs)..................                                        7,851

Interest revenue (10% x $21,488: from schedule).........................                                        2,149

* If paid previously.

Requirement 11

December 31, 2025

Yard Art Landscaping (Lessee)
Maintenance expense (2025 fee)...................................................                 1,000
     Prepaid maintenance expense (paid in 2024)............................                                        1,000

Amortization expense ($35,313 ÷ 4 years)....................................                 8,828
     Right-of-use asset.....................................................................                                        8,828

Loss on residual value guarantee ($6,000 – 4,000).......................                 2,000

     Cash (annual payment plus $6,000 – 4,000).............................                                        2,000

Branch Motors (Lessor)
Equipment (actual residual value).................................................                 4,000
Cash ($6,000 – 4,000)...................................................................                 2,000
Loss on leased assets ($15,000 – 6,000)........................................                 9,000
     Lease receivable (account balance)...........................................                                      13,637

Interest revenue (10% x $13,637: from schedule).........................                                        1,363