Question

P20.14 Dubois Steel Corporation, as lessee, signed a lease agreement for equipment for five years, beginning January 31, 2020. Annual rental payments of $41,000 are to be made at the beginning of each lease year (January 31). The insurance and repairs and maintenance costs are the lessee’s obligation. The interest rate used by the lessor in setting the payment schedule is 9%; Dubois’s incremental borrowing rate is 10%. Dubois is unaware of the rate being used by the lessor. At the end of the lease, Dubois has the option to buy the equipment for $4,000, which is considerably below its estimated fair value at that time. The equipment has an estimated useful life of seven years with no residual value. Dubois uses straight-line depreciation on similar equipment that it owns, and follows IFRS 16.

Instructions

a. Answer the following questions, rounding all numbers to the nearest dollar.

b. Using (1) time value of money tables, (2) a financial calculator, or (3) Excel functions, calculate the PV of the lease obligation.

c. Prepare the lease amortization schedule for the lease. (Hint: You may find the ROUND formula helpful for rounding in Excel.)

d. Prepare the journal entry or entries that should be recorded on January 31, 2020, by Dubois.

e. Prepare any necessary adjusting journal entries at December 31, 2020, and the journal entry or entries that should be recorded on January 31, 2021, by Dubois. Dubois does not use reversing entries.

f. Prepare any necessary adjusting journal entries at December 31, 2021, and the journal entry or entries that should be recorded on January 31, 2022, by Dubois.

g. What amounts would appear on Dubois’s December 31, 2021 SFP relative to the lease arrangement?

h. What amounts would appear on Dubois’s statement of cash flows for 2020 relative to the lease arrangement? Provide the classification of the amounts reported.

i. Assume that the leased equipment had a fair value of $200,000 at the inception of the lease, and that no bargain purchase option is available at the end of the lease. Would your treatment of the lease change for financial reporting purposes?