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Horton Company, as lessee, enters into a lease agreement on July 1, 2008, for
equipment. The following data are relevant to the lease agreement:
1. The term of the noncancelable lease is 4 years, with no renewal option. Payments
of $422,689 are due on June 30 of each year.
2. The fair value of the equipment on July 1, 2008 is $1,400,000. The equipment has
an economic life of 6 years with no salvage value.
3. Horton depreciates similar machinery it owns on the sum-of-the-years'-digits basis.
4. The lessee pays all executory costs.
5. Horton's incremental borrowing rate is 10% per year. The lessee is aware that the
lessor used an implicit rate of 8% in computing the lease payments (present value
factor for 4 periods at 8%, 3.31213; at 10%, 3.16986.
Instructions
(a)
Indicate the type of lease Horton Company has entered into and what accounting
treatment is applicable.
(b)
Prepare the journal entries on Horton's books that relate to the lease agreement
for the following dates: (Round all amounts to the nearest dollar. Include a partial
amortization schedule.)
1. July 1, 2008.
2. December 31, 2008.
3. June 30, 2009.
4. December 31, 2009.
Solution 21-103
(a)
Capitalized amount:
$422,689 PV of an ordinary annuity for 4 periods at 8%
$422,689 3.31213 = $1,400,000
Because the present value of the lease payments ($1,400,000) equals the fair
value, $1,400,000, of the leased property, it is a capital lease and must be
accounted for under the capital lease method.
(b)
1.
July 1, 2008
Leased Equipment Under Capital Leases............................... 1,400,000
Lease Liability.............................................................
1,400,000
2.
280,000
56,000
Annual
Interest on
Reduction of
Balance of
Lease Payment
Unpaid Obligation
Lease Obligation
Lease
Obligation
7/1/08
$1,400,000
6/30/09
$422,689
$112,000
$310,689
1,089,311
6/30/10
422,689
87,145
335,544
753,767
3.
112,000
Lease Liability..........................................................................
310,689
Cash..............................................................................
422,689
(Interest payable entry assumed to have been
reversed 1/1/09)
4.
490,000
43,573
Interest Payable.............................................................
43,573
1. Rental payments of $219,000 including $19,000 for property taxes, payable at the
beginning of each six-month period.
2. A termination penalty assuring renewal of the lease for a period of four years after
expiration of the initial lease term.
3. An option allowing the lessor to extend the lease one year beyond the last renewal
exercised by the lessee.
4. A guarantee by Forbes Company that Holt Corp. will realize $100,000 from selling
the asset at the expiration of the lease. However, the actual residual value is
expected to be $60,000.
Instructions
(a)
(b)
(c)
(d)
What is the present value of the minimum lease payments? (PV factor for annuity
due of 20 semi-annual payments at 8% annual rate, 14.13394; PV factor for
amount due in 20 interest periods at 8% annual rate, .45639.) (Round to nearest
dollar.)
(e)
What journal entries would Forbes record during the first year of the lease?
(Include an amortization schedule through 1/1/09 and round to the nearest dollar.)
Solution 21-104
(a)
This lease is a capital lease to Forbes Company because its term (10 yearssee
computation in b below) exceeds 75% of the equipment's estimated useful life. In
addition, the present value (see computation in d below) of the minimum lease
payments (see computation in c below) exceeds 90% of the fair value of the
equipment ($3,000,000).
(b)
years
years
year
10
years
(c)
$ 219,000
Executory costs
(19,000)
200,000
20
4,000,000
Residual guarantee
100,000
$4,100,000
200,000
2,826,788
Factor for present value of $1 due in 20 interest periods at 4%
Residual guarantee
.45639
100,000
45,639
Present value of lease payments
$2,872,427
(e)
January 1, 2008
Leased Equipment Under Capital Leases.................................... 2,872,427
Lease Liability...................................................................
2,872,427
January 1, 2008
Leases Liability.............................................................................
200,000
Property Taxes.............................................................................
19,000
Cash.................................................................................
219,000
July 1, 2008
Lease Liability...............................................................................
93,103
19,000
106,897
Cash.................................................................................
219,000
Lease Amortization Schedule
Semi-Annual
Date
Lease Payment
Interest
Reduction of
4%Lease Obligation
Balance
Initial PV
$2,872,427
1/1/08
$200,000
$200,000
2,672,427
7/1/08
200,000
106,897
93,103
2,579,324
1/1/09
200,000
103,173
96,827
2,482,497
281,243*
103,173
fourteen years, and a salvage value of zero at the end of that time (due to
technological obsolescence).
3. National Airlines will pay all executory costs related to the leased airplane.
4. Annual year-end lease payments of $5,766,425 allow Jenks to earn an 8% return
on its investment.
5. Collectibility of the payments is reasonably predictable, and there are no important
uncertainties surrounding the costs yet to be incurred by Jenks.
Instructions
(a)
(b)
Prepare a lease amortization schedule for the lessor for the first two years (20082009). (Round all amounts to nearest dollar.)
(c)
Prepare the journal entries on the books of the lessor to record the lease
agreement, to reflect payments received under the lease, and to recognize
income, for the years 2008 and 2009.
Solution 21-105
(a)
The lease is a direct-financing type lease from the lessor's point of view or a
capital lease from the lessee's point of view. The lease contains a bargain
purchase option which satisfies one of the criteria for classification as a directfinancing lease. The option to buy for $9,000,000 at the termination of the lease
when the asset is expected to have a fair value of $15,000,000 constitutes a
bargain purchase option. Additionally, the payments are collectible, and there are
no uncertainties as to future lessor costs.
(b)
Annual
Interest on
Lease Receivable
Lease Rental
Lease Receivable
Recovery
Lease
Receivable
1/1/08
$38,000,000
12/31/08
$5,766,425*
$3,040,000
$2,726,425
35,273,575
12/31/09
5,766,425
2,821,886
2,944,539
32,329,036