TUTORIAL SHEET # 5 LEASING

TUTORIAL SHEET Unit 7 LEASING

1. IAS 17 defines a finance lease as:

a) a lease where the lessor retains substantially all the risks and rewards of ownership of an asset

b) a lease of assets other than land and buildingsc) a lease where legal title may be acquired by exercising an option to purchase an asset once certain conditions are fulfilledd) a lease that transfers substantially all the risk and rewards of ownership of an asset to the lessee2. Lease M does not contain a bargain purchase option, but the lease term is equal to 90% of the estimated economic life of the leased property. Lease P does not transfer ownership of the property to the lessee at the end of the lease term, but the lease term is equal to 75% of the estimated economic life of the leased property. How should the lessee classify these leases?

Lease M

Lease P

a) Finance Lease

Operating Lease

b)

Finance Lease

Finance Lease

c)

Operating LeaseFinance Lease

d)

Operating LeaseOperating Lease

3. For a finance lease, the amount recorded initially by the lessee as a liability should normally:

a) Exceed the total of the minimum lease payment

b) Exceed the present value of the minimum lease payments at the beginning of the lease

c) Equal the total of the minimum lease payments

d) Equal the present value of the minimum lease payments at the beginning of the lease

4.At the inception of a finance lease, the guaranteed residual value should be:

a) Included as part of minimum lease payments at present value

b) Included as part of minimum lease payments at future value

c) Included as part of minimum lease payment only to the extent that guaranteed residual value is expected to exceed estimated residual value

d) Excluded from minimum lease payments

5.On January 2, 1997, Nori Mining Co. (lessee) entered into a 5-year lease for drilling equipment. Nori accounted for the acquisition as a capital lease for $240,000, which includes a $10,000 bargain purchase option. At the end of the lease, Nori expects to exercise the bargain purchase option. Nori estimates that the equipments fair value will be $20,000 at the end of its 8-year life. Nori regularly uses straight-line depreciation on similar equipment. For the year ended December 31, 1997, what amount should Nori recognize as depreciation expense on the leased asset?

a) $48,000

b) $44,000

c) $30,000

d) $27,500

6.On January 2, 1998. Elsee Co. leased equipment from Grant, Inc. Lease payments are $100,000, payable annually every December 31, for 20 years. Title to the equipment passes to Elsee at the end of the lease term. The lease is noncancellable.

Additional Facts

a) The equipment has a $750,000 carrying amount on Grants books. Its estimated economic life was 25 years on January 2, 1998.

b) The rate implicit in the lease, which is known to Elsee, is 10%. Elsees incremental borrowing rate is 12%.

c) Elsee uses the straight-line method of depreciation.

The rounded present value factors of an ordinary annuity for 20 years are as follows:

12%

7.46944

10%

8.51356

Required:

Prepare the necessary Journal Entries, to be recorded by Elsee for:

1. Entering into the lease on January 2,1998

2. Making the lease payment on December 31, 1998

3. Expenses related to the lease for the year ended December 31, 1998

7.A 3-year lease is initiated on January 1, 1995 for equipment with an expected useful life of 6 years. The equipment reverts back to the lessor upon expiration of the lease agreement. Three payments are due to the lessor in the amount of $60,000 per year beginning December 31, 1995. A additional sum of $4,000 is to be paid annually by the lessee for insurance. The lessee guarantees a $5,000 residual value on December 31, 1997 to the lessor. The leased asset is expected to also have a $5,000 salvage value on December 31, 1997; therefore the asset should be depreciated down to the $5,000 expected residual value. The lessees incremental borrowing rate is 12% (same as the lessors implicit rate).

Note (PVIFA 12%,6) = 4.1114 ; (PVIF 12%,6) = 0.5066 ; (PVIFA 12%,3) = 2.4018 ; and (PVIF 12%,3) = 0.7118

Required:

a) Why will the above lease be classified as a finance lease?

b)Record all the necessary entries in the books of the lessee over the life of the lease.

c)What amount will be shown on the lessees balance sheet for lease obligation outstanding as at December 31, 1996?

d) What are the total cash payments made by the lessee over the life of the lease?

8.A 4-year lease is initiated on January 1, 1994 for equipment with an expected useful life of 7 years. Four (4) annual payments of $50,000 each are due to the lessor beginning December 31, 1994. The lessee can exercise a bargain purchase option on December 31,1997 for $5,000. The expected residual value at December 31, 2000 is $3,000. The lessees incremental borrowing rate is 15% (lessors implicit rate is unknown).

Note (PVIFA 15%,7) = 4.1604 ; (PVIF 15%,7) = 0.3759 ; (PVIFA 15%,4) = 2.8550; and (PVIF 15%,4) = 0.5718

Required:

a)Why will the above lease be classified as a finance lease?

b) Record all the necessary entries in the books of the lessee over the life of the lease.

c)What amount will be shown on the lessees balance sheet for lease obligation outstanding as at December 31,1995.

9.The following facts pertain to a lease between Sun Bank Leasing and JMJ Schmitt Printers for an electronic printer:

1. The lease is for a five-year term, beginning January 1,1999. The remaining economic life of the asset is five years.

2. The lessors implicit rate is 10%; the lessees incremental borrowing rate is 10%.

3. The fair value of the leased asset is $100,000.

4. The annual rent payments are $26,379.73; the first one is due on December 31,1999.

5. The title to the asset automatically transfers to the lessee at the end of the lease term. The asset is expected to have a fair value of $5,000 at that date.

PVIFA (10%, 5) = 3.79079

Required:

1. Describe the type of lease from the viewpoint of the lessee

2. Prepare an amortization schedule for use by the lessee.

3. Prepare the journal entry to record the inception of the lease on the lessees books.

4. Indicate the amount (s) to appear in the lessees December 31, 2000 balance sheet for the lease. Also indicate the portion that will appear in the current liability section, and the portion that will appear in the long-term liability classification.

10.Baloo is an incorporated enterprise that has arranged to lease a machine from Bagira starting on 1 July 2002. The terms of the lease are that Baloo will make an advance payment on 1 July 2002 of $30,000, and two other annual payments to Bagira of $30,000 each. The purchase price of the machine for cash, and the cost to Bagira is $74,746. The interest rate implicit in the lease is 22%. Baloo makes up its accounts to 30 June. The companys depreciation policy for this type of machine is 30% per annum on the reducing balance.

Required:

a)Explain the difference between a finance lease and an operating lease.

b)Whats the advantage of leasing an asset rather then buying?

c)What are the main differences in accounting terms between the two types of leases?

d)Assuming the above lease is an operating lease show how Baloo would account for the transaction in its income statement and balance sheet for the year ending 30 June.

e)What are the situations in which a lease would normally be classified as a finance lease?

f)Assuming the above lease is a finance lease prepare the following in the books of Baloo so far as the information permits:

i) An amortization schedule;

ii) Income Statement extracts for the years ending 30 June 2003, 2004, 2005

iii) Balance Sheet extract for the years ending 30 June 2003, 2004, 2005.

iv) What are the disclosure requirements for the above lease?

g)What qualitative and quantitative areas need to be considered when leasing an asset?

Illustration of disclosure requirements Finance Lease

The following disclosure would be appropriate:

Extract from Balance Sheet

Non-Current Assets:

$

Leased Property under finance lease

xxx

Less: Accumulated Depreciation

(xxx)

NBV

xxx

Non-Current Liabilities:

Non-current obligations under finance lease

xxx

Current Liabilities:

Current obligations under finance lease

xxx

Notes to the financial statements Obligations under finance lease

The future minimum lease payments to which the company is committed as at 20XX are:

Minimum Lease Payments

Amounts PayableNet Present Value

$

$Amounts payable next year

xxxx

xxxx

Amounts payable after more than one year

and not later than five years

xxxx

xxxx

Amounts payable later than five years

xxxx

xxxx

Extract from significant accounting policies

Where assets are financed by leasing agreements that give rights approximately to ownership (finance lease), the assets are treated as if they had been purchased outright at the present value of the total rentals payable during the primary period of the lease. The corresponding leasing commitments are shown as obligations to the lessor.

Charges are made to the income statement in respect of:

Depreciation which is provided on the straight line basis over the economic life of the asset.

The total finance charge which is allocated over the primary period of the lease using the actuarial method.11