Question

The following facts pertain to a noncancelable lease agreement between Groh Leasing Company and MS Cody Company, a calendar year lessee. January 1, 2013 S37,000 Inception date: Annual lease-payment due at the beginning of each year, beginning with January 1,2013 including $2000.00 of executory costs Lease term Economie life of leased equipment Bargain purchase option Fair value of asset at January 1, 2013 Lessor's implicit rate (known to lessee) Lessee's incremental borrowing rate 4 years 5 years $5,000 $125,455 10% 1196 Instructions: Explain what type of lease this is to the lessee. Be clear!! Identify ALL of the tests passed. 1. 2. Compute the present valne of ALL the minimem lease paynents (Reund all calculations to nearest doller) Record all of the entries required by the lessee on 1-1-2013. 3. 193 4. Complete the lessee's amortization schedule for the first TWO years. The company's year-end is December 31. (Round all calculations to nearest dollar Interest Reduction in Lease Lease Date MLP Liability Liability 1-1-13 1-1-13 1-1-14 1-1-15 -- 15 1-1-16 12-31-16 35000 3 5 000 35oo0 5. Record all the proper adjusting entries for lessee at the end of the first year (12-31-13). Show what the relewant-seetions of the 12-31-13 Balance Sheet would look like with respect to this lease. 6. 7. Show the relevant 2013 income statement accounts and amounts reported under this lease. uSe Rack avez le o he lase pulk CAsh o

Answer 1

Solution: 1) Type of Lease: There are two types of lease, Finance Lease and Operating Lease To be a finance lease: There must be a non cancelable agreement between the lesse and the lessor Should meet atlease any one of the 5 below mentioned condition. 1) Transfer of asset test. Are the underlying asset transferred to the Lessee at the end of the agreement term. 2) Purchase Option test. Will the lease agreement grant the lessee an option to purchase the asset. And the lesse is reasonably certain to exercise. 3) Lease Term Test. Is the lease term agreement covers major part of the economic life of the underlying asset. 75% of the assets economic life of the asset. 4) Present Value Test: We commute the present value of the lease payment and the any residual value of the asset. If the amount equals or exceed 90% of the Fair Value of the Asset. of the lease agreement.

Fair Value of the Asset $125,455 Lease Term = 4 Years Lease Commence on January 1st 2013 Lease Expires on 31st December 2016 Asset will not be returned @ 31st December 2016, there is a Bargain Purchase @ $5,000 Economic Life of the Asset 5 Years Annual Payments Due on Jan 1st $37,000 implict Rate of interest of Lessor = 10 % Computation of Present Value of Lease payment is done using implicit interest rate of the Lessor Fair Value of the Asset Bargain Purchase Present Value amount 10% after 4 Yrs Present Value Lease Payment Present Value amount 10% for 4 Yrs Present Value amount Present value of the amount % $1,25,455 $5,000 0.6830 $3,415 $37,000 Executory Cost is the Part of lease Payment. 3.4869 $1,32,430 Present Value of the Bargain Price is also included 106% 1) Executory Cost of $ 2,000 every year shows that the Transfer of ownership will happened at the end of Lease 2) Lease agreeement provides with Bargain Purchase option. 3) Lease term-4/5-80 % which is greater than 75 % 4) Present Value Test. $117,286/$ 125,455-106962 90% 5) Alternative use test. Lessor can rent it again Therefore, This is a Finance Lease

Under Finance Lease we need to show Right of Use Assset and Lease Liability in the Balance Sheet. In the Income Statement both the Amortization Expense and Lease expense are shown Entries in the Book of MS Cody Company (Under Flnance Lease On January 1st 2013 Record Right to Use the Asset Right of use Asset A/C Dr $1,32,430 To Lease Liability $1,32,430 To Record the First Lease Payment on January 1st 2013 Lease Liability A/C Dr $37,000 To Cash A/C 37,000 To Record the Lease expense on December 31st 2013 Lease Expense A/C Dr $9,543 To Lease Liability $9,543 Amortization A/C Dr $33,108 To Right to Use Account $33,108 To Record the Second Lease Payment on January 1st 2014 Lease Liability A/C Dr $37,000 $37,000 To Cash A/C To Record the Lease expense on December 31st 2014 Lease Expense A/CDr $6,797 To Lease Liability $6,797 Amortization A/C Dr $33,108 To Right to Use Account $33,108 To Record the Third Lease Payment on January 1st 2015 Lease Liability A/C Dr $37,000 To Cash A/C $37,000 To Record the Lease expense on December 31st 2015 Lease Expense A/C Dr 3,777 To Lease Liability $3,777 455 To Lease Liability Lease Expense A/C Dr $455 Amortization A/C Dr $33,108 To Right to Use Account $33,108 To Record the Third Lease Payment on January 1st 2016 Lease Liability A/C Dr $37,000 To Cash A/C 37,000 To Record the Lease expense on 31st Deceber 2016 Amortization A/C Dr $33,108 To Right to Use Account 33,108

Lease Amortizaion Schedule in the Books of MS Co Annual Lease Payment Reduction of Lease Liability Lease Liabilit Interest on Date 01-01-2013 01-01-2013 01-01-2014 01-01-2015 01-01-2016 01-01-2016 Liability 10% $1,32,430 $95,430 $67,973 $37,770 $4,547 $0 $37,000 $37,000 $37,000 $37,000 $5,000 $37,000 $27,457 $30,203 $33,223 $4,545 $0 $9,543 $6,797 $3,777 $455

4th Question Solution Entries in the Book of MS Cody Company (Under Flnance Lease] On January 1st 2013 Record Right to Use the Asset Right of use Asset A/C Dr $1,32,430 To Lease Liability $1,32,430 To Record the First Lease Payment on January 1st 2013 Lease Liability A/C Dr $37,000 $37,000 To Cash A/C

5th Question Solution To Record the Lease expense on December 31st 2013 Lease Expense A/C Dr $9,543 To Lease Liability $9,543 Amortization A/C Dr $33,108 To Right to Use Account $33,108

6th Question Solution Balance Sheet as on 31st December 2013 Liabilities $1,32,430 Lease Liability $1,32,430 Total Liability Assets $1,32,430 Right To Use Asset $1,32,430 Total Asset

7th Question Solution Income Statement for 31st December 201:3 Lease Expense Debit Credit Total $9,543 $33,108 Amortisation Expense $42,651