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1-1-08, Kimberly-Clark Corp. signs 10-year, non-cancelable leaseagreement to lease a storage building from Sheffield Storage Co. KC is LESSEE.
• Equal rent payments of $72,000 starting 1/1/08• FMV of building 1-1-08 is $440,000.• Blding has economic life of 12 years, with Unguaranteed R.V. of $10,000. ST-LINE depreciation.• NON-renewable lease. Building reverts to lessor at termination
of lease (THUS NO BPO).• KC (LESSEE’S) incremental borrowing rate 12% annual.• LESSOR’S rate is unknown.• Yearly rent payment includes $2,470.51 of executory costs
related to taxes on property.
Instructions: Prepare journal entries on LESSEE’s BOOKSto reflect signing lease and payments/expenses for 08 and 09.Year end 12/31.
Expenses of ownership and use (e.g.,insurance, tax, maintenance).
How are they accounted for in an OPERATING LEASE?
Paid by lessor and recovered in periodic rent payments.
How are they accounted for in a capital lease?
LESSOR LESSEE
If lessor retains responsibilityfor payment
DON’T capitalize intoPV of minimum lease payments;
executory costs subtractedfrom lease payment beforePV min lease payments calculated
If paid directly by lessee tothe third party
No need to adjust the rent payment because it doesn’tinclude the executory costs.
How much then are the yearly rent payments?
Capitalized amount of the lease:Yearly payment $ 72,000.00Executory costs 2,470.51Minimum annual lease payment $69,529.49
What is the PRESENT VALUE of the minimum lease payments?
Present value of minimum lease payments$69,529.49 X 6.32825 = $440,000.00
10 years at 12%
What entry records the lease obligation for the LESSEE?
1/1/08 Leased Asset 440,000.00 Lease Liability 440,000.00
What entry records the first lease payment?
1/1/08 Executory Costs—Property Taxes 2,470.51Lease Liability 69,529.49
Cash 72,000.00
What other entries are needed for the LESSEE?
DEPRECIATION
12/31/05 Depreciation Expense 44,000.00 Accumulated Depreciation—
Capital Leases 44,000.00($440,000 ÷ 10)
INTERESTtable next slide.
* Don’t subtract salvage because its unguaranteed and no transfer of ownership.
Schedule 1 Kimberly-Clark Paper Co.Lease Amortization Schedule
(Lessee)
Annual Payment Reduction BalanceLess of Lease of Lease
Date Executory Costs Interest (12%) Obligation Obligation
1/1/08 $440,000.001/1/08 $69,529.49 -0- $69,529.49 370,470.511/1/09 69,529.49 $44,456.46 25,073.03 345,397.481/1/10 69,529.49 41,447.70 28,081.79 317,315.69
INTEREST for 2008
12/31/08 Interest Expense …………….. 44,456.46accrued Lease Liability (int/p) 44,456.46* payment made in cash on 1/1/09
Payment on 1/1/09
1/1/09 Executory Costs—Property Taxes 2,470.51Interest Payable (lease liab) 44,456.46Lease Liability 25,073.03
Cash 72,000.00
Other entries
12/31/09 Depreciation Expense 44,000.00 Accumulated Depreciation—
Capital Leases 44,000.00
12/31/09 Interest Expense 41,447.70 Lease Liability (int/p)….. 41,447.70
Castle Leasing Co. signs lease on 1-1-08 to lease electronicequipment to Jan Way Co.
• 2 year lease• Payments at END of year.• BPO for $16,000 at termination of lease.• Cost/FMV of equipment is $160,000 to Castle.
• Economic life is 2 years.• Residual value is $16,000
• Executory costs of $5,000/yr paid by Jan Way (LESSEE)• Castle leasing desires 10% return.• Collectibility of payments reasonably predictable and no important uncertainties surround costs yet to be incurred.
a. Prepare entries for CASTLE (LESSOR) for 2008 and 2009
How much is the lease payment? LESSOR figures this out.
The formula:
PV of min lease = (Rent x factor) + (BPO x factor)
$160,000
FMV usually same thing
= (Rent x What Rate?)
RULE ON WHAT RATE TO USE FOR DISCOUNTING
LESSEE
Uses the lower of his/her rate or the lessors;To find leased asset.
LESSOR
Uses his/her own rate.
How much is the lease payment? LESSOR figures this out.
The formula:
PV of min lease = (Rent x factor) + (BPO x factor)
$160,000
FMV usually same thing
= (Rent x What Rate?)
Lessor wants to earn 10%
How much is the lease payment?
The formula:
PV of min lease = (Rent x factor) + (BPO x factor)
$160,000 = (Rent x 1.73554) + ($16,000 X .82645)
Table 6-4 (2 years @ 10%; ordinary annuity)
Table 6-2 (2 years @ 10%; lump sum)
How much is the lease payment?
The formula:
PV of min lease = (Rent x factor) + (BPO x factor)
$160,000 = (Rent x 1.73554) + ($16,000 X .82645)
Table 6-4 (2 years @ 10%; ordinary annuity)
Table 6-3 (2 years @ 10%; lump sum)
RENT = $84,571.26
How much is the balance of lease receivable?
$160,000 (same as PV of lease)
What does the interest table look like?
Castle Leasing Company (Lessor)Lease Amortization Schedule
Annual Payment Interest NetLease On Net Investment Net
Date Investment Recovery Investment
1/1/08 $160,000.0012/31/08 $84,571.26 $16,000.00 $68,571.26 91,428.7412/31/09 84,571.26 009,142.52* 75,428.74 16,000.00
$25,142.52
*Difference of $.35 due to rounding.
Entry on 1/1/08 to initiate lease LESSOR
(a) 1/1/08 Lease Payments Receivable 160,000Equipment 160,000.00
Entries on 12/31/08
To record lease receipt.
Cash ($84,571.26 + $5,000) 89,571.26Executory CostsPayable 5,000.00Lease Receivable 68,571.26Interest Revenue 16,000.00
12/31/09 Cash 89,571.26Executory Costs Payable 5,000.00Lease Payments Receivable 75,428.74Interest Revenue................ 9,142.52
B. If Jan Way uses BPO, what journal entry reflects the sale?
Cash…………….. $16,000Lease Payments Receivable…. $16,000
T-account analysis of Lease Receivable next slide.
Lease Receivable
$160,000 $68,571.26
$75,428.74
$16,000This is theBPO
Crosley Company, a machinery dealer, leased a machine to Dexter Corporationon January 1, 2007. The lease is for an 8-year period and requires equal annualpayments of $35,013 at the beginning of each year.
The first payment is received on January 1, 2007. Crosley had purchased themachine during 2006 for $160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amountof costs yet to be incurred by Crosley. Crosley set the annual rental to ensurean 11% rate of return. The machine has an economic life of 10 years withno residual value and reverts to Crosley at the termination of the lease.
(a) Compute the amount of the LEASE RECEIVABLE.
$35,013 X 5.7122 = $200,001
Entry to record the lease at its inception for Crosley
Lease payments receivable..... $200,001
Inventory (equipment)................ $160,000 (book)
Cost of goods sold.................... 160,000
Sales............................................ $200,001 (FMV)
(b) Prepare all necessary journal entries for Crosley for 2007.
Entry to record the first lease payment (receipt)
Cash.......... $35,013Lease payments receivable........ $35,013
Entry to record interest revenue adjustment.
($200,001 - $35,013) = $164,987 x .11= $18,148
Interest Receivable............. $18,148Interest revenue......................$18,148
Noncancellable lease between Mike Mooney Leasing (OR) and Denise Rode (EE).
•Inception (May 1, 2007)•Annual rent (Due at beginning of year starting 5/1/07); $21,227.65•BPO at EOL… $4,000.•Lease term 5 years•Economic life- 10 years•Lessor’s cost.. $65,000•FMV on 5/1/07… $91,000•Lessors ROR… 10%•Lessee’s ROR… 10%•Lessee assumes all executory costs.
A. Discuss the NATURE of this lease to RODE (LESSEE).
collectibility reasonably predictable.
no important uncertainties surrounding costsyet to be incurred by lessor.
lessee assumes responsibility for all executory costs
The lease agreement has a BPO and, thus meets the criteria to be classified asa capital lease from the viewpoint of the lessee. The present value of the minimum lease payments exceeds 90% of the FMV of the assets.
B. Discuss the nature of the lease to MOONEY Company (LESSOR).
The lease agreement has a BPO. The collectibility of the lease paymentsis reasonably predictable, and there are no important uncertainties surroundingthe costs yet to be incurred by the lessor. The lease, therefore, qualifies as a capital type lease from the viewpoint of the lessor. Due to the fact that the initialamount of net investment (which in this case equal the present value of theminimum lease payments, $91,000) exceeds the lessor’s cost of $65,000, the leaseis a SALES TYPE LEASE.
C. Prepare Lease Amortization schedule for RODE (LESEE).
Need the PV of the minimum lease payments.
Should be $91,000 (FMV of asset).
($21,227.65 x 4.16986) + ($4,000 x .62092) = $91,000
rent 10%, 5 yrsT 6-5 BPO
10%, 5 yrsT 6-2
Denise Rode Company (LESSEE)Lease Amortization Schedule
AnnualLease Reduction BalancePayment Interest (10%) on unpaid of lease
Date Plus BPO Obligation Obligation Obligation
5/1/07 $91,000
5/1/07 $21,227.65 $21,227.65 69,772.35
5/1/08 $21,227.65 $6,977.24 14,250.41 55,521.945/1/09 21,227.65 5,552.19 15,675.46 39,846.485/1/10 21,227.65 3,984.65 17,243.00 22,603.485/1/11 21,227.65 2,260.35 18,967.30 3,636.184/30/12 4,000.00 363.82 3,636.18 -0-
-------------- ------------ -------------$110,138.25 $19,138.25 $91,000
D. Prepare journal entries on the LESSEE’s books. Reversingentries ARE USED by RODES.
Entries needed on 5/1/07
Leased asset……….. $91,000Lease liability………$91,000
Lease liability…. $21,227.65Cash……………$21,227.65
Entries needed on 12/31/07
To record interest
Interest expense… $4,651.49Interest payable… $4,651.49
6977.24 x 8/12 = 4651.49
To record depreciation
Depreciation expense… $6,066.67Accumulated depreciation……. $6,066.67
$91,000 / 10 = $9,100.00
$9,100 x 8/12 = $6,066.67LIFE of assetbecause of BPO(no salvage is mentioned)
Entries on 1/1/08
Interest payable……. $4,651.49Interest expense……. $4,651.49 REVERSING
Entries for 5/1/08
Interest expense… $6977.24Lease Liability…. $14,250.41
Cash…………….$21,227.65
Entries for 12/31/08
Interest expense…….. $3701.46 (5552 x 8/12)Interest payable……..$3701.46
Depreciation Expense….. $9100Accumulated depreciation….$9100
Continuation of E 21-8
A. Compute the amount of Lease Receivable at the start of the lease.
($21,227.65 x 4.16986) + ($4,000 x .62092) = $91,000
B. Prepare the lease amortization schedule for MOONEY
AnnualLease Interest Net NetPayment (10%) on Investment Investment
Date Plus BPO Investment Recovery
5/1/07 $91,000
5/1/07 $21,227.65 $21,227.65 69,772.355/1/08 21,227.65 6,977.24 14,250.41 55,521.945/1/09 21,227.65 5,552.19 15,675.46 39,846.485/1/10 21,227.65 3,984.65 17,243.00 22,603.485/1/11 21,227.65 2,260.35 18,967.30 3,636.184/30/12 4,000.00 363.82 3,636.18 -0-
-------------- ----------- ---------------$110,138.25 $19,138.25 $91,000.00
D. Prepare journal entries for MOONEY. Reversing NOT used.
Record the signing of the lease.
Lease Receivable…. $91,000
Sales……. $91,000
COG………………. $65,000
Inventory.. $65,000
The first lease payment.
Cash……. $21,227.65Lease Receivable…. $21,227.65
12/31/07 Adjust the interest.
Interest Receivable....… $4,651.49Interest revenue……………..$4,651.49
$6,977.24 x 8/12 = $4,651.49
5/1/08 Receipt of cash payment.
Cash…….. $21,227.65Lease Receivable…… $14,250.41Interest Receivable.....$ 4,651.49Interest Revenue....... .$ 2325.72 ($6,977.21 - $4,651.49)
Adjustment of interest 12/31/08Interest Receivable… $3,701.46
Interest revenue………….$3,701.46
$5,552.19 x 8/12 = $3,701.46
Rest of the entries for 2009
5/1/09 Cash…… $21,227.65Lease receivable…….$15,675.46Interest Receivable....$ 3,701.46Interest Revenue........$ 1,850.73 (5,552.19 - $3,701.46)
12/31/09 Interest Receivable.......… $2,656.43Interest revenue…………$2,656.43
* 8/12 adjustment (3,984.65 x 8/12 ) = $2,656.43
Morgan Marie Leasing Co. signs an agreement on January 1, 2004 to leaseequipment to Cole William Company. The following information relates to this agreement.
1. The term of the noncancelable lease is 6 years with no renewal option.The equipment has an estimated economic life of 6 years.
2. The cost of the asset to the lessor is $245,000. The fair value of the asset at January 1, 2004 is $245,000.
3. The asset will revert to the lessor at the end of the lease term at whichtime the asset is expected to have a residual value of $43,622, noneof which is guaranteed.
4. Cole William Company assumes direct responsibility for all executorycosts. (LESSEE RESPONSIBLE).
5. The agreement requires equal annual rental payments, beginningon January 1, 2004.
6. Collectibility of the lease payments is reasonably predictable. There areno important uncertainties surrounding the amount of costs yet to beincurred by the lessor.
Instructions:
a. Assuming the lessor desires a 10% rate of return on its investment,calculate the amount of the annual rent payment.
FMV = (Rent x factor) + (Residual value x factor)
$245,000 4.790796 per @ 10%
$43,622 .56447
$46,000
B. Prepare an amortization schedule that would be suitable for the lessorfor the lease term.
Morgan Marie Leasing Company (Lessor)Lease Amortization Schedule
AnnualLease Interest Net Balance
Date Payment (10%) on Invest- of NetPlus URV Net Invest. ment Recovery Investment
1/1/04 $245,0001/1/04 $46,000 $46,000 199,0001/1/05 46,000 19,900 26,100 172,9001/1/06 46,000 17,290 28,710 144,1901/1/07 46,000 14,419 31,581 112,6091/1/08 46,000 11,261 34,739 77,8701/1/09 46,000 7,787 38,213 39,65712/31/09 43,622 3,965 39,657 0
------------ ---------- ------------- ------------------- $319,622 $ 74,622 $245,000
C. Prepare all of the journal entries for the LESSOR for 2004 and 2005.
To record inception of lease 1/1/04
Lease Receivable…………… $319,622Equipment……………………$245,000Unearned interest revenue…. 74,622
To record receipt of first cash payment on 1/1/04
Cash………………. $46,000Lease Receivable………… $46,000
To record accrual of interest on 12/31/04
Unearned interest revenue………. $19,900Interest revenue………………….$19,900
Receipt of second payment on 1/1/05
Cash…………….. $46,000Lease Receivable……….. $46,000
Accrual of interest on 12/31/05
Unearned interest revenue…… $17,290Interest revenue……………..$17,290