Chapter 18: Accounting for Leases
Assignment 18-3
Requirement 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.
- Guaranteed residual, none.
- 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.
- Bargain purchase option, none.
- Bargain renewal terms, $29,500 per year for the second five-year lease term
- Minimum net lease payment:
(a)($79,600 – $7,900) × 5 years $358,500
(b)($29,500 – $2,500) × 5 years 135,000
$493,500
- 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
Year / Opening / Interest / Cash / Incr/(Decr) / Endingbalance / @7% / payment / in balance / balance
20X4 / $ 658,082 / $ 0 / $ 150,000 / $ (150,000) / $ 508,082
20X5 / 508,082 / 35,566 / 150,000 / (114,434) / 393,648
20X6 / 393,648 / 27,555 / 150,000 / (122,445) / 271,203
20X7 / 271,203 / 18,984 / 150,000 / (131,016) / 140,187
20X8 / 140,187 / 9,813 / 150,000 / (140,187) / 0
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
Year / Opening / Interest / cash / Incr/(Decr) / Endingbalance / @6% / payment / in balance / balance
20X4 / 669,766 / – / 150,000 / (150,000) / 519,766
20X5 / 519,766 / 31,186 / 150,000 / (118,814) / 400,952
20X6 / 400,952 / 24,057 / 150,000 / (125,943) / 275,009
20X7 / 275,009 / 16,501 / 150,000 / (133,499) / 141,510
20X8 / 141,510 / 8,491 / 150,000 / (141,509) / 0
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