Question

Please show all work On January 1, 2019, Kimberly Clark Corp. signed a 6-year noncancelable lease agreement to lease an industrial-strength mulching machine. The following information pertains to this lease. 1. Kimberly Clark is required to make equal annual rental payments of $80,116, with the first payment due on January 1, 2019, the date the lease was signed. 2. The fair value of the machine on January 1, 2019, was S400,000. 3. The machine has an estimated economic life of 10 years. 4. The term of the lease is 6 years. 5. Kimberly Clark depreciates similar machines using the straight-line method. 6. The lease is nonrenewable. At the termination of the lease, the equipment reverts to the lessor. 7. At the end of the lease term, the lessor expects to be able to resell the equipment for $35,000. Kimberly Clark is not guaranteeing that residual value. 8. Kimberly Clark's incremental borrowing rate is 8% per year. The lessor's implicit rate is not known by Kimberly Clark. 1. State your conclusion regarding how Kimberly Clark (the lessee) should classify this lease. 2. Prepare dated journal entries to record all of the transactions that Kimberly Clark needs to record for the year ending December 31, 2019. 3. Compute the amount of Interest Expense and the amount of Amortization Expense that Kimberly Clark should report in its 2019 Income Statement. 4. Compute the amount of the Right-of-Use Asset and the amount of the Lease Liability that Kimberly Clark should report in its 2019 Dola

Answer 1

Answer-1:

There are different test that are used to determine whether the lease is to be classified a financing lease or operating lease;

a) Economic Life Test: Under this test if the lease period covers the major part of the asset’s economic life (i.e. 75%) then the capitalization of lease is appropriate because covering major part of asset’s economic life transfers most of the risks and rewards of ownership to the lessee.

   Economic life of the Asset = 10 years

   Lease Period = 6 years

As the lease period covers only 60% of the economic life of the project, so as per economic life test it is a operating lease.

b) Transfer of Ownership Test: As the machine will revert to lessor after termination of lease, it doesn’t transfer ownership of the asset to the Kimberly Clark, this lease is a operating lease.

C) Recovery of Investment Test: under this test if the present value of the minimum lease payments equals or exceeds the fair value of the asset then lease is classified as financing lease.

Fair Value of the Machine = 400,000

PV of Minimum lease Payment = 80,116 * (PV annuity due factor @8% for 6 years)

                                                                = 80,116 * 4.99 = 399,778

As per this test, lease also not satisfy to be a financing lease as pv of minimum lease payments are less than fair    value of the machine.

Kimberly Clark should classify the lease as a operating lease.

Answer-2:

As the lease has been classified as operating lease, Kimberly Clark will record the rent expense every period as follow:

Date	Accounts	Debit	Credit
Jan 1, 2019	Rent Expense	80,116
	Cash		80,116

Answer-3:

As the lease has been classified as operating lease, there will be no amortization schedule.

Answer-4:

As the lease has been classified as financing lease, there will be no impact on balance sheet.