Chapter 17: Accounting for Leases

Chapter 18: Accounting for Leases

Assignment 18-3

Requirement 1

1. The lease term is 10 years. The second five-year lease term is a bargain renewal option, based on the information regarding market rental rates.
2. Guaranteed residual, none.
3. Unguaranteed residual exists as the value of the asset to the lessor at the end of the lease term. There is no way to calculate this amount.
4. Bargain purchase option, none.
5. Bargain renewal terms, $29,500 per year for the second five-year lease term
6. Minimum net lease payment:

(a)($79,600 – $7,900) × 5 years $358,500

(b)($29,500 – $2,500) × 5 years 135,000

$493,500

1. Incremental borrowing rate, 8%

Requirement 2

To be a capital lease, the lease would have to meet one of three criteria, applied judgementally:

1.Transfer of title or BPONo

2.Economic life vs. lease termYes; 10/12 = 83% of the lease term

3.PV of MLP vs. fair valueYes; $388,418* = 90% of $430,000

* PV of MLP:

(a)PV1 = ($79,600 – $7,900) (P/AD, 8%, 5)

= $71,700 × 4.31213 = $309,180

(b)PV2 = ($29,500 – $2,500) (P/AD, 8%, 5) (P/F, 8%, 5)

= $27,000 × (4.31213) × (.68058) = 79,238

$388,418

Requirement 3

Beginning of fiscal year and lease term:

Asset under capital lease 388,418

Lease liability 388,418

Insurance expense 7,900

Lease liability 71,700

Cash 79,600

End of fiscal year:

Interest expense 25,337

Lease liability 25,337

[($388,418 – $71,700) × .08]

Depreciation expense 38,842

Accumulated depreciation 38,842

[$388,418÷ 10]

Assignment 18-11

Present value of the lease payments:

PV = $15,000 × (P/AD, 8%, 5) = $15,000 × (4.31213) = $64,682

The present value is 90% of the fair value of $72,000. Also, the lease is for a major portion (5/7) of the equipment’s economic life. The remaining two years of life (after the end of the lease term) are not likely to be of any value to NLC. Thus, this almost certainly is a finance lease.

Requirement 1 – Amortization table

OutstandingInterest1 OctoberInc/(Dec)Ending

Year Balance at 8% Cash Flow in Balance Balance

20X1 64,682 — 15,000 (15,000) 49,682

20X2 49,682 3,975 15,000 (11,025) 38,657

20X3 38,657 3,093 15,000 (11,907) 26,750

20X4 26,750 2,140 15,000 (12,860) 13,890

20X5 13,890 1,111 15,000 (13,889)0

Requirement 2 – Entries for 20X1 and 20X2

1 October 20X1:

Asset under finance lease 64,682

Lease liability 64,682

Lease liability 15,000

Cash 15,000

31 December 20X1:

Interest expense ($49,682 × 8% × 3/12) 994

Lease liability 994

Depreciation expense ($64,682 × 3/60) 3,234

Accumulated depreciation—leased asset 3,234

1 October 20X2:

Lease liability 15,000

Cash 15,000

31 December 20X2:

Interest expense* 3,754

Lease liability 3,754

Depreciation expense ($32,341 × 12/60) 6,468

Accumulated depreciation—leased asset 6,468

*($49,682 × 8% × 9/12) + ($38,657 × 8% × 3/12) = $2,981 + $773 = $3,754

Requirement 3

On 31 December 20X2, the current liability is the amount of principal included in the next lease payment (i.e., on 1 October 20X3) plus the interest accrued between 1 October 20X2 and 31 December 20X2:

Principal component of 1 Oct 20X3 payment* $ 11,907

Accrued interest ($38,657 × 8% × 3/12) 773

Current portion of lease 12,680

Long-term portion ($38,657 – $11,907) 26,750

Lease liability, total $39,430

* from amortization table

Assignment 18-12

Requirement 1

PV of lease payments: $150,000 (P/AD, 7%, 5) = $150,000 × 4.38721 = $658,082

Requirement 2

Statement of financial position:

Equipment under finance lease$658,082

Less accumulated depreciation (131,616)

Net$526,466

Current liability for capital lease*$150,000

Long-term liability for capital lease**$393,648

The total lease liability at 31 Dec 20X4 is $508,082 principal

plus $35,566 interest = $543,648

* Of that amount, the current portion is the $150,000 due

the next day, (consisting of $114,434 principal plus

$35,566 accrued interest)

** The long-term portion is (1) the principal plus interest liability of $543,648 (i.e., $508,082 + $35,566) minus the next-day payment of $150,000, or

(2) the remaining principal payments: 122,445 + 131,016 + 140,187 = $393,648

Statement of comprehensive income, earnings section:

Depreciation expense$131,616

Interest expense (from amortization table) 35,566

Cash flow statement:

Operating activities—non-cash expense add-backs:

Depreciation $131,616

Interest 35,566

Financing activities—finance lease payment 150,000

Requirement 3 — Yvan Ltd. entries for 20X4 and 20X5:

2 January 20X4:

Asset under finance lease 658,082

Lease liability 658,082

Lease liability 150,000

Cash 150,000

31 December 20X4:

Interest expense 35,566

Lease liability 35,566

Depreciation expense ($658,082 ÷ 5) 131,616

Accumulated depreciation—asset under lease 131,616

2 January 20X5:

Lease liability 150,000

Cash 150,000

31 December 20X5:

Interest expense 27,555

Lease liability 27,555

Depreciation expense 131,616

Accumulated depreciation—asset under lease 131,616

Assignment 18-13

Requirement 1

PV of lease payments: $150,000 (P/AD, 6%, 5) = $150,000 × 4.46511 = $669,766

Requirement 2

Jeffrey Leasing Inc. entries for 20X4 and 20X5, net method:

2 January 20X4:

Lease receivable 669,766

Cash, accounts payable (or Asset available for lease) 669,766

Cash 150,000

Lease receivable 150,000

31 December 20X4:

Lease receivable 31,186

Finance income–leases 31,186

2 January 20X5:

Cash 150,000

Lease receivable 150,000

31 December 20X5:

Lease receivable 24,057

Finance income–leases 24,057

Requirement 3

Jeffrey Leasing Inc. entries for 20X4 and 20X5, gross method:

2 January 20X4:

Lease payments receivable ($150,000 × 5) 750,000

Unrealized finance income 80,234

Cash, accounts payable (or Asset available for lease) 669,766

Cash 150,000

Lease payments receivable 150,000

31 December 20X4:

Unrealized finance income 31,186

Finance income–leases 31,186

2 January 20X5:

Cash 150,000

Lease payments receivable 150,000

31 December 20X5:

Unrealized finance income 24,057

Finance income–leases 24,057

Assignment 18-17

Requirement 1 – Lease Amortization Schedule, Beginning of Lease Year Payments

PV = $4,100(P/AD, 12%, 5) + $500(P/AD, 12%, 3)(P/F, 12%, 5)

PV = $4,100 (4.03735) + $500 (2.69005)(0.56743)

PV = $17,316

LeaseOpeningInterest1 JanuaryInc/(Dec)Ending

Year Balance at 12% Payment in Balance Balance

20X2 $17,316 $ 0 $4,100 $(4,100) $13,216

20X3 13,216 1,586 4,100 (2,514) 10,702

20X4 10,702 1,284 4,100 (2,816) 7,886

20X5 7,886 946 4,100 (3,154) 4,732

20X6 4,732 568 4,100 (3,532) 1,200

20X7 1,200 144 500 (356) 844

20X8 844 101 500 (399) 446

20X9 446 54 500 (446) 0

$4,683

Requirement 2 – Entries

20X2 20X3

1 January

Asset under finance lease ...... 17,316

Lease liability...... 17,316

Lease liability...... 4,100 4,100

Insurance and maintenance expense 1,700 1,700

Cash...... 5,800 5,800

31 December

Interest expense...... 1,586 1,284

Lease liability...... 1,586 1,284

Depreciation expense...... 2,165 2,165

Accumulated depreciation,

leased asset ($17,316 ÷ 8)... 2,165 2,165

Requirement 3

Income Statement 20X2 20X3

Maintenance and insurance expense $1,700 $1,700

Interest expense 1,586 1,284

Depreciation expense 2,165 2,165

Statement of Financial Position

Capital assets

Assets under capital leases 17,316 17,316

Accumulated depreciation (2,165) (4,330)

15,151 12,986

Current liabilities

Current portion of lease liability 4,100 4,100

Long-term liability

Lease liability 14,802* 11,986*

Less: current portion 4,100 4,100

10,702 7,886

*$13,216 + $1,586; $10,702 + $1,284

Statement of Cash Flows

Operations:

Addbacks: Depreciation 2,165 2,165

Increase(decrease) in interest payable 1,586 (302)

Financing:

Repayment of lease liability (4,100)* (2,514)**

*$17,316 – $14,802 = $(2,514); $1,586 interest and $(4,100) principal repayment. May also be shown as the net $(2,514) change in lease liability: $17,316 – $14,802 = ($2,514). Practice differs.

**$14,802 – $11,986 = ($2,816); ($302) interest ($1,586 versus $1,284) and $(2,514) prinicpal repayment. May also be shown as the net ($2,816) change in lease liability: $14,802 – $11,986 = ($2,816).

Requirement 4

Allocation of Interest Expense to Fiscal Years:

ImplicitAllocationInterest

Lease PaymentInterest(5/12: 7/12)ExpenseYear End

20X2 $ 0 0

20X3 1,586 661 $661 31 May 20x2

925

20X4 1,284 535 1,460 31 May 20X3

749

20X5 946 394 1,143 31 May 20X4

552

20X6 568 237 789 31 May 20X5

331

20X7 144 60 391 31 May 20X6

84

20X8 101 42 126 31 May 20X7

59

20X9 54 23 82 31 May 20X8

31

20X10 0 0 31 31 May 20X9

$4,683 $4,683 $4,683

Assignment 18-20

Requirement 1

31 March 20X2:

Cash 9,000,000

Accumulated depreciation 3,600,000

Distribution facility 10,400,000

Deferred gain on sale and leaseback 2,200,000

Distribution facility under lease 8,706,346

Lease liability 8,706,346

($875,000 × P/AD 9%, 20) = ($875,000 × 9.95011)

Lease liability 875,000

Cash 875,000

31 December 20X2:

Interest expense 528,616

Lease liability 528,616

($8,706,346 – $875,000) × 9% × 9/12

[New balance: $8,706,346 – $875,000 + $528,616 = $8,359,962]

Depreciation expense 326,488

Accumulated depreciation, leased

distribution facility 326,488

($8,706,346 ÷ 20 × 9/12)

Deferred gain on sale and leaseback 82,500

Depreciation expense 82,500

($2,200,000 ÷ 20 × 9/12)

Requirement 2

31 March 20X3:

Interest expense 176,205

Lease liability 176,205

($8,706,346 – $875,000) × 9% × 3/12

Lease liability 875,000

Cash 875,000

[New balance: $8,359,962 + $176,205 – $875,000 = $7,661,167]

31 December 20X3:

Interest expense 517,129

Lease liability 517,129

($7,661,167 × 9% × 9/12)

[New balance: $7,661,167 + $517,129 = $8,178,296]

Depreciation expense 435,317

Accumulated depreciation, leased

distribution facility 435,317

($8,706,346 ÷ 20)

Deferred gain on sale and leaseback 110,000

Depreciation expense 110,000

($2,200,000 ÷ 20)

Interest expense 176,205

Lease liability 176,205

[($8,706,346 – $875,000) × 9% × 3/12]

Lease liability 875,000

Cash 875,000

[New balance: ($8,706,346 – $875,000 + $528,616 + $176,205 –

$875,000) = $7,661,167]

31 March 20X4:

Interest expense 172,376

Lease liability 172,376

($7,661,167 × 9% × 3/12)

Lease liability 875,000

Cash 875,000

[New balance: $8,178,296 + $172,376 – $875,000 = $7,475,672]

31 December 20X4:

Interest expense 504,608

Lease liability 504,608

($7,475,672 × .09 × 9/12)

[New balance: $7,475,672 + $504,608 = $7,980,280]

Depreciation expense 435,317

Accumulated depreciation, leased

distribution facility 435,317

Deferred gain on sale and leaseback 110,000

Depreciation expense 110,000

Requirement 3

20X220X320X4

Statement of Financial Position:

Capital Assets

Distribution facility under capital lease $8,706,346 $8,706,346 $8,706,346

Less: accumulated depreciation 326,488 761,805 1,197,122

$8,379,858 $7,944,541 $7,509,224

Deferred credits

Deferred gain on sale and leaseback 2,117,500 2,007,500 1,897,500

Long-term liability

Lease liability 8,359,962 8,178,296 7,980,280

Income Statement:

Interest expense 528,616 693,334 676,984

Depreciation expense 243,988 325,317 325,317