Lease Problems Hw1

8/19/2019 Lease Problems Hw1

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Lease problems:

Homework 1 – due Tu March 6, 2012

Problem 2

On January 1, Year 1, Burton Company leases equipment from Nelson Company for an annual leaserental of $10,000. The lease term is five years and the lessors interest rate impli!it in the lease is "#. Thelessees in!remental orro%in& rate is ".'(#. The useful life o the equipment is five years, and itsestimated residual value equals its removal !ost. )nnuity tales indi!ate that the present value of anannual lease rental of $1 *at "# rate+ is $.-- *three dollars and --. !ents+. The fair value of leasedequipment equals the present value of the rentals. )ssume the lease is !apitalied.

a. /repare a!!ountin& entries required y Burton for Year 1. . Compute and illustrate the effe!t on the in!ome statement for the year ended e! 1, Year 1, and

for the alan!e sheet as of e!. 1, Year 1.!. Constru!t a tale sho%in& payments of interest and prin!ipal made every year for the five year

lease termd. Constru!t a tale sho%in& epenses !har&ed tot eh in!ome statement for the five year lease term

if the equipment is leased. 2ho% a !olumn for amortiation, interest and total epenses.e. is!uss the in!ome and !ash flo% impli!ations from this !apital lease.

Problem 2

On January 1, Borman Company, a lessee, entered into three non3!an!ellale leases for ne% equipment

identified as J, 4 and 5. None of the three leases transfers o%nership of the equipment to Borman at the

end of the lease term. 6or ea!h of the three leases, the present value at the e&innin& of the lease term of

the minimum lease payments e!ludin& that portion of the payments representin& ee!utor !osts su!h as

insuran!e, maintenan!e, and taes to e paid y the lessor, in!ludin& any profit thereon, is 7(# of the

e!ess of the fair value of the equipment to the lessor at the in!eption of the lease over any related

investment ta !redit retained y the lessor and epe!ted to e realied y the lessor. The follo%in&

additional information is distin!t for ea!h lease8

5ease J does not !ontain a ar&ain pur!hase option9 the lease term is equal to "0# of the estimated

e!onomi! life of the equipment.

5ease 4 !ontains a ar&ain pur!hase option9 the lease term is equal to (0# of the estimated e!onomi! life

of the equipment.

5ease 5 does not !ontain a ar&ain pur!hase option9 the lease term is equal to (0# of the estimated

e!onomi! life of the equipment.

Required

a. :plain ho% Borman Company should !lassify ea!h of these three leases. ;hy<

. =dentify the amount, if any, Borman re!ords as a liaility at the in!eption of the lease for ea!h of

the three leases.

!. )ssumin& that Borman ma>es the minimum lease payments on a strai&ht line asis, des!rie ho%

Borman should re!ord ea!h minimum lease payment for ea!h of these three leases.



d! )ssess a!!ountin& pra!ti!e in a!!urately portrayin& the e!onomi! reality for ea!h lease.



Lease Problems: Homework 1 due Mar 6, 2012

"#L$T%#&:

Problem 1 (40 minutes)

a. 1/1/Year 1 Enter into Lease Contract Leased Property under Capital Leases ................................ 39,930

Lease Obliation under Capital Leases...........................39,930

1!/31/Year 1 Payment of Rental "nterest on Leases .................................................................. 3,194.40 (1)Lease Obliations under Capital Leases ............................. #,$0%.#0

Cas& ...................................................................................

10,000

Amortization of Property Rights'mor. o Leased Property under Capital Leases ................ ,9$# (!)

Leased Property under Capital Leases .......................... ,9$#

(1) *39,930 + .0$ *3,194.40(!) *39,930 % *,9$#

b.

-alane &eeteember 31, Year 1

'2 L"'-"L"2"

Leased property under Lease Obliations under apital leases *31,944 (1) apital leases. *33,1!4.40(!)

"nome tatementor Year nded eember 31, Year 1

'morti5ation o leased property .................................................. * ,9$#.00"nterest on leases........................................................................... 3,194 .402otal lease6related ost or Year 1 ............................................... *11,1$0 .40 (3)

(1) *39,930 6 *,9$# *31,944(!) *39,930 6 *#,$0%.#0 *33,1!4.40



(3) 2o be ontrasted to rental osts o *10,000 7&en no apitali5ation ta8es plae.

.

Payments o "nterest and Prinipal

2otal "nterest Payment o Prinipal Year Payment at $ Prinipal -alane*39,930.00

1 10,000 *3,194.40 *#,$0%.#0 33,1!4.40! 10,000 !,#49.9% ,3%0.0% !%,4.3%3 10,000 !,0#1.9% ,93$.0% 1,$3#.304 10,000 1,4!#.90 $,%3.10 9,!#3.!0% 10,000 3#.$0 9,!#3.!0

*%0,000 *10,00.00 *39,930.00 :

d.

+penses to -e C&ared to "nome tatementLease 2otal

Year +pense 'morti5ation "nterest +penses1 *10,000 * ,9$#.00 * 3,194.40 *11,1$0.40! 10,000 ,9$#.00 !,#49.9% 10,#3%.9%3 10,000 ,9$#.00 !,0#1.9% 10,04.9%4 10,000 ,9$#.00 1,4!#.90 9,41!.90% 10,000 ,9$#.00 3#.$0 $,!!.$0

*%0,000 *39,930.00 *10,00.00 *%0,000.00

e. 2&e inome and as& lo7 impliations rom t&is apital lease are apparent int&e solutions to parts c and d . 2&e student s&ould note t&at reportede+penses e+eed t&e as& lo7s in earlier years, 7&ile t&e re;erse ours inlater years.



Problem ! (30 minutes)

a. ' lease s&ould be lassiied as a apital lease 7&en it transers substantiallyall o t&e beneits and ris8s in&erent to t&e o7ners&ip o property by meetinany one o t&e our riteria or lassiyin a lease as a apital lease.

peiially< Lease = s&ould be lassiied as a apital lease beause t&e lease term is

e>ual to $0 perent o t&e estimated eonomi lie o t&e e>uipment, 7&i&e+eeds t&e % perent or more riterion.

Lease ? s&ould be lassiied as a apital lease beause t&e lease ontainsa barain pur&ase option.

Lease L s&ould be lassiied as an operatin lease beause it does notmeet any o t&e our riteria or lassiyin a lease as a apital lease.

b. -orman reords t&e ollo7in liability amounts at ineption< or Lease =, -orman reords as a liability at t&e ineption o t&e lease an

amount e>ual to t&e present ;alue at t&e beinnin o t&e lease term o minimum lease payments durin t&e lease term, e+ludin t&at portion o t&e payments representin e+eutory osts su& as insurane,maintenane, and ta+es to be paid by t&e lessor, inludin any proitt&ereon. @o7e;er, i t&e amount so determined e+eeds t&e air ;alue o t&ee>uipment at t&e ineption o t&e lease, t&e amount reorded as a liabilitys&ould be t&e air ;alue.

or Lease ?, -orman reords as a liability at t&e ineption o t&e lease anamount determined in t&e same manner as or Lease =, and t&e paymentalled or in t&e barain pur&ase option s&ould be inluded in t&eminimum lease payments.

or Lease L, -orman does not reord a liability at t&e ineption o t&elease.

. -orman reords t&e ALPs as ollo7s< or Lease =, -orman alloates ea& minimum lease payment bet7een a

redution o t&e liability and interest e+pense so as to produe a onstantperiodi rate o interest on t&e remainin balane o t&e liability.

or Lease ?, -orman alloates ea& minimum lease payment in t&e samemanner as or Lease =.

or Lease L, -orman &ares minimum lease (rental) payments to rental

e+pense as t&ey beome payable.

d. rom an analysis ;ie7point, bot& apital and operatin leases representeonomi liabilities as t&ey in;ol;e ommitments to ma8e i+ed payments. 2&eat t&at ompanies an struture leases as Boperatin leasesB to a;oidbalane s&eet reonition is problemati rom t&e perspeti;e o analysis o assets. " t&e leased assets are used to enerate re;enues, t&ey s&ould be



onsidered in ratios su& as return on assets and ot&er measures o inanialperormane and ondition.

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Lease Problems Hw1