Question

E21-4 (L02,4) EXCEL (Lessee Entries, Finance Lease and Unguaranteed Residual Value) Assume that on December 31, 2016, Kimberly-Clark Corp. signs a 10-year, non-cancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement. 1. The agreement requires equal rental payments of $71,830 beginning on December 31, 2016. 2. The fair value of the building on December 31, 2016, is $525,176. 3. The building has an estimated economic life of 12 years, a guaranteed residual value of $10,000, and an expected residual value of $7,000. Kimberly-Clark depreciates similar buildings on the straight-line method. 4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor. 5. Kimberly-Clark's incremental borrowing rate is 8% per year. The lessor's implicit rate is not known by Kimberly-Clark. Instructions (a) Prepare the journal entries on the lessee's books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2016, 2017, and 2018. Kimberly-Clark's fiscal year-end is December 31. (b) Suppose the same facts as above, except that Kimberly-Clark incurred legal fees resulting from the execution of the lease of $5,000, and received a lease incentive from Sheffield to enter the lease of $1,000. How would the initial measure ment of the lease liability and right-of-use asset be affected under this situation? (c) Suppose that in addition to the $71,830 annual rental payments, Kimberly-Clark is also required to pay $5,000 for insur- ance costs each year on the building directly to the lessor, Sheffield Storage. How would this executory cost affect the initial measurement of the lease liability and right-of-use asset? (d) Return to the original facts in the problem. Now suppose that, at the end of the lease term, Kimberly-Clark took good and Sheffield agrees that the fair value of the asset is actually $10,000. Record the entry for Kimberly- Clark at the end of the lease to retur control of the storage building to Sheffield (assuming the accrual of interest on the lease liability has already been made).

Answer 1

Answer is given below

Calculation of Lease Liability Outflow Total PV PV Factor $71,830 $3,000 Present value of Rental payment Present value of guaranteed residual value ($10,000- $7,000) Present value of minimum lease payment $520,544 7.2469 $1,501 0.5002 $522,045 Fair value of building Lower of PV of Minimum lease payments or Fair value of building Lease Liability will be lower of above 2 $525,176 $522,045 Amortisation Schedule Reduction Annual Opening Interest Lease of Date Lease Liability Balance at 8% Liability Payment $71,830 $71,830 $71,830 $0 $450,215 $414,402 $522,045 $71,830 31-12-2016 $35,813 $38,678 $36,017 $33,152 $450,215 31-12-2017 $414,402 $375,724 31-12-2018 Amortisation expenses will be Right to Use Asset value/10 years $52,204 a) Debit Journal Credit Date 31-12-2016 Right to Use Asset To Lease Liability $522,045 $522,045 (Being Lease recorded in books) 31-12-2016 Lease Liability To Cash $71,830 $71,830 (Being first payment of Lease Liability recorded) $52,204 31-12-2017 Amortization expenses $52,204 To Right to use of Asset Being amortisation of right to use asset recorded) 31-12-2017 Lease Liability Interest Expense $35,813 $36,017 $71,830 To Cash (Being Lease Liability and Interest |recorded) $52,204 31-12-2018 Amortization expenses To Right to use of Asset (Being amortisation of right to use asset recorded) $52,204 31-12-2018 Lease Liability $38,678 Interest Expense To Cash $33,152 $71,830 (Being Lease Liability and Interest recorded) Calculation of the Right-of- use asset b) Lease Liability $522,045 $5,000 -$1,000 $526,045 Lease Fees Lease incentives Right-to-use Asset Initial Direct Cost and lease incentive do not affect the initial measurement of lease liability They only affect the measurement of right too use Asset Annual insurance Cost $5,000 c) Qutflow Total PV PV Factor Present value of Rental payment Present value of guaranteed residual value ($10,000 $7,000) Present Value of Annual Insurance payment Present value of minimum lease payment $71,830 $520,544 7.2469 $3,000 $1,501 0.5002 $5,000 $36,234 7.2469 $558,279 The annual insurance payment is considered part of annual payments similar to rental payments The present value of annual insurance payments should be included in initial measurement of lease liability and right to use the asset also d) Journal Date Debit Credit 31-12-2026 Lease Liability To Gain on lease $3,000 $3,000