Week 5 (SU 10 Bonds and 11 Leases) Sp24 to present(2)

docx

School

University of Texas, Dallas *

*We aren’t endorsed by this school

Course

6291

Subject

Accounting

Date

Feb 20, 2024

Type

docx

Pages

Uploaded by ConstableSnow2537

e. Bond date B. coupon A. Face (maturity) value f. Issuance date G. Maturity date H. Term C. Pay dates I.Proceeds D. Market Int J.Bond Issuance CPA Review – FAR – Spring 2024 - Week 5 Handouts (covers SU 10 and 11) 10.1 and 10.3 Types of Bond Liabilities and Bonds Payable – Initial Measurement A. Face (maturity) value B. Stated (coupon) interest rate C. Interest payment dates D. Market (yield, effective) interest rate E. Bond date F. Issuance date G. Maturity date H. Bond term I. Bond proceeds J. Bond issuance costs On January 1, Year 1 the company issued $700,000 of 12% bonds , dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years on December 31, Year 3. The market yield for bonds of similar risk and maturity is 14% . $700,000 of the issuance was purchased by ABC. The bonds sold for $666,633 and the company incurred $100,000 in costs to issue the bonds. 10.3 Calculate the PV or Price of the bonds: PV of Annuity Stream of Cash Interest 12%*700K*1/2 = 42,000 4.76654*$42k cash =$200,195 n= 6 i= 14%* ½ = 7% PV of Principle 0.66634*700k = 466,438 N = 6 i= 14%* ½ = 7% Selling price of the Bond or PV of the Bond $666,633 1.Prepare the Bond Amortization table for the initial $700,000 bond issuance. MARKET Selling price of the Bond or PV of the Bond $666,633 0.06 0.07 DISCOUNT Dates Cash Inter Exp Change Carry Value/OS Balance inception - 1/1/20 - - 33,367.00 $666,633 6/30/2020 42,000.00 46,664.31 4,664.31 671,297.31 12/31/2020 42,000.00 46,990.81 4,990.81 676,288.12 6/30/2021 42,000.00 47,340.17 5,340.17 681,628.29 12/31/2021 42,000.00 47,713.98 5,713.98 687,342.27 6/30/2022 42,000.00 48,113.96 6,113.96 693,456.23 12/31/2022 42,000.00 48,543.94 6,543.94 700,000.00 <-- GOAL *never change 700,000.17 (0.17) Calculate the ENTIRE amortization schedule using the market interest rate on the date of issuance – do not adjust in the future 1 st Interest payment date  6/30/20 At Dec. 31, 2021, what entry would be recorded? Interest expense 46,664 Interest expense 47,714 Discount 4,664 Discount 5,714 CASH 42,000 CASH 42,000 1 PV Principal PV - OA interest = n= % % US > Market premium ----------------------------------------------------- US < Market discount % %

2.The following information pertains to Camp Corp.'s issuance of bonds on July 1, 20X5: Face amount $800,000 Ordinary Annuity = On the Border ( eat, then pay) *Normal for bonds!! Annuity due = Dairy Queen (Pay, then eat) *Normal for LEASES!!! Term 10 years Stated interest rate 6 %  cash interest Interest payment dates Annually on July 1 Yield 9%  market Factors At 6% At 9% 1,000.00 0.42 422.00 60.00 6.42 385.08 807.08 Present value of 1 for 10 periods 0.558 0.422 Future value of 1 for 10 periods 1.791 2.367 Present value of ordinary annuity of 1 for 10 periods 7.360 6.418 What should be the issue price for each $1,000 bond? A. $1,000 B. $864 C. $807 D. $700 3. On July 1, 2019, Noble, Inc. issued 9% bonds in the face amount of $10,000,000, which mature on July 1, 2025 . The bonds were issued for $ 9,560,000 to yield 10%, resulting in a bond discount of $440,000. Noble uses the effective- interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2021, Noble's unamortized bond discount should be A . $322,400. B. $340,000. C. $352,000. D. $310,000. What is considered long-term/noncurrent liability? If does not meet the definition of a current liability, it must be long-term. Bonds Sold Between Interest Dates - Buyer pays the issues the amount of interest that has accrued since the last payment date in addition to the purchase price of the bonds 4.1.2021 (Bond date) 7.1.2021 (Bonds sold) 10.1.2021 (Interest date) Issued 4.On July 1, 2021, Spear Co. issued 4,000 of its 10%, $1,000 bonds at 99 plus accrued interest . The bonds are dated April 1, 2021 and mature on April 1, 2031. Interest is payable semiannually on April 1 and October 1. What amount did Spear receive from the bond issuance? a. $4,060,000 b. $4,000,000 c. $3,960,000 d. $3,860,000 Pay attention: Look at dates! Year end dates are not always the same as the interest payment dates. All interest rates are expressed at annual rates, so be sure to adjust for the time period. 2 900,000.00 0.09 0.10 DISCOUNT Dates Cash Inter Exp Change Carry Value/OS Balance inception -7/1/19 - - 440,000.00 $9,560,000 6/30/2020 900,000.00 956,000.00 56,000.00 9,616,000.00 6/30/2021 900,000.00 961,600.00 61,600.00 9,677,600.00 322,400.00 Bond proceeds PLUS Accrued interest 4,000#*$1000 = 4,000,000 * .99 = 3,960,000 discount Cash interest = 4m *.10 * ½ year = $200,000 for 6 months Prepaid for (3/6) = 50% Preaid interest of 200k * 50% = 100k Cash received 3,960,000+ 100,000 accrued interest = 4060000 Dr. Cash 4,060,000 Dr. Discount 40,000 Cr. Int payable 100,000 (or Interest exp) Cr. Bonds payable 4,000,000

5.On January 1, 2021, Solis Co. issued its 10% bonds in the face amount of $8,000,000, which mature on January 1, 2031. The bonds were issued for $ 9,080,000 to yield 8%, resulting in bond premium of $1,080,000 . Solis uses the effective- interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2021, Solis's adjusted unamortized bond premium should be a. $1,080,000. b. $1,006,400. c. $972,000. d. $812,000. SU 10.5 Debt Issuance Costs Costs to bring debt to market – printing, legal, accounting, underwriters, promotion costs Balance Sheet: RECORD as a Contra-liability (so they have a debit balance). Not an asset!!! When present, net against face amount of the debt. Income Statement: AMORTIZE using effective interest method into interest expense (unless state use S/L) 6.Determine Proper Amounts in Account Balances. Presented below are three independent situations. a.Snider Corporation incurred the following costs in connection with the issuance of bonds : (1) printing and engraving costs $40,000; (2) legal fees $120,000, and (3) commissions paid to underwriter $320,000. What amount should be reported as Unamortized Bond Issue Costs, and where should this amount be reported on the balance sheet ? 40,000 +120,000 + 320,000 = $480,000 Contra-liability nets with the bonds payable on the B/S b. Banks Co. sold $5,000,000 of 6%, 10-year bonds at 104 on January 1, 2020. The bonds were dated January 1, 2020, and pay interest on July 1 and January 1 . If Banks uses the straight-line method to amortize bond premium or discount , determine the amount of interest expense to be reported on July 1, 2020, and December 31, 2020. Issuance Cash (5m*1.04) 5,200,000 Premium 200,000 Bonds Payable 5,000,000 July 1 **Use S/L for interest expense Interest expense 140,000  plug Premium* 10,000 Cash 150,000 *200,000/ 20# n = 10,000 amort December 31  no cash until 1/1 Interest expense 140,000  plug Premium* 10,000 Int payable 150,000 January 1 (next day) Interest payable 150,000 Cash 150,000 c.Cey Inc. issued $1,000,000 of 10%, 10-year bonds on June 30, 2020, for $885,296 . This price provided a yield of 12% on the bonds. Interest is payable semiannually on December 31 and June 30. If Cey uses the effective-interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2020 . Issue 6.30.2020  pay interest 12.31.2020 Interest exp for 10.31.20 Carrying value $885,296 * 12% * ½ year = 53,118 PROPRaTE – expense for 4 of the 6 months over 6.00 months 8,852.96 35,411.84 months Inter expense 35,412 Discount 2,079 Inter payable (1m* 10%*1/2 yr * 4/6) 33,333 3 Issue 1.1.21  premium at 12.31.21 8,000,000.00 MARKET Selling price of the Bond or PV of the Bond 800,000.00 0.10 0.08 Premium Dates Cash Inter Exp Change Carry Value/OS Balance Inception 1.1.21 - - 1,080,000.00 $9,080,000 12/31/21/ 800,000.00 726,400.00 (73,600.00) 9,006,400.00 1,006,400.00 Can use effective or S/L amortization of discount/ premium – have to show that it’s not a material difference

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

7.On December 1, 2021, Lester Company issued at 103, eight hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 shares of Lester's common stock. On December 1, 2021, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock purchase warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be a. $774,560. b. $782,800. c. $800,000. d. $824,000. SU 10.6 Extinguishment of Debt Debt Retirement Principles - Must Know: Financial statement presentation Calculation of bond net carrying value Calculation of gain or loss on extinguishment  PLUG from everything When bonds are retired at maturity, the final payment extinguishes the liability  GOAL! No I/s Impact!!! When bonds are retired before maturity, the final payment is compared to net book value and a gain or loss is recognized Net book value = face +/– unamortized premium/discount –unamortized bond issue costs [contra-liability acct] Gains/Losses are recognized in earnings in the period of extinguishment Can only derecognize the liability if it (1) pays and is relieved of obligation OR (2) is legally released 8.On January 1, 2021, Goll Corp. issued 3,000 of its 10%, $1,000 bonds for $3,120,000. These bonds were to mature on January 1, 2031 but were callable at 101 any time after December 31, 2024 . Interest was payable semiannually on July 1 and January 1. On July 1, 2026 , Goll called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Before income taxes, Goll's gain or loss in 2026 on this early extinguishment of debt was a. $90,000 gain. b. $36,000 gain. c. $30,000 loss. d. $24,000 gain. JE @ issuance Cash 3,120,000 Premium 120,000 Bonds payable 3,000,000 Premium Amort 120,000 S/L N=20# PREMIUM AMORT PER PERIOD = 120K/20 = 6,000 Amortized premium = 6k * 11n# = 66,000 Unamortized premium = 54,000 JE @ Retirement Bonds payable 3,000,000 Premium 54,000 GAIN (plug) 24,000 Cash (101) 3,030,000 4 **check coverage on 2024 FAR** 1.1.21 12.31.22 12.31.23 12.31.24 12.31.25 12.31.26 # years Year 1 # I pays 2 2 2 2 2 1 – 7.1.26 Total n’s = 11#

9.A ten-year bond was issued in 2019 at a discount with a call provision to retire the bonds . When the bond issuer exercised the call provision on an interest date in 2021, the carrying amount of the bond was less than the call price. The amount of bond liability removed from the accounts in 2021 should have equaled the a. call price. b. call price less unamortized discount. c. face amount less unamortized discount. d. face amount plus unamortized discount SU10.7 Noncurrent Notes Payable – may require no payments, just interest payments or interest + principle payments over time 10.Entries for Zero-Interest-Bearing Note On December 31, 2020, Payson Company acquired a press from Sugar Corporation by issuing a $400,000 zero-interest-bearing note, payable in full on December 31, 2023 . Payson’s credit rating permits it to borrow funds from its several lines of credit at 8%. The press is expected to have a 6-year life and a $40,000 salvage value. Prepare the journal entry for the purchase on December 31, 2020. PVF n=3, I = 8 .79383 * 400,000 = 317,532 PV of my NP Equipment (PV of the NP) 317,532 NP Discount 82,468 Notes payable (gross) 400,000 Date Cash Payment Effective Interest Change in Balance Outstanding Balance 12/31/2020 - - 82,468.00 317,532.00 - 25,402.56 25,402.56 342,934.56 - 27,434.76 27,434.76 370,369.32 - 29,631.55 29,631.55 400,000.00 <-- goal 400,000.87 12/31/2021 12/31/2022 12/31/2023 Prepare any necessary adjusting entries relative to depreciation (use straight-line) and amortization (use effective- interest method) on December 31, 2022. Depr = (317,532 – 40,000 SV)/ 6 year = 46,255 Depr exp 46,255 Interest expe 27,434.76 Accum dep 46,255 Np Discount 27,434.76 5 Issued in 2019 (made up numbers) Cash 3,000 Discount 1,000 Bonds payable 4,000 Called in 2021….. CV< Call price CV 3,500, < Call 4,000 Bonds payable 4,000 Discount 1,000 Cash 4,000

11.Entries for Zero-Interest-Bearing Note; Payable in Installments North Sea Drilling Co. purchased machinery on December 31, 2019, paying $100,000 down and agreeing to pay the balance in f ou r equal installments of $125,000 payable each December 31. An assumed interest of 6% is implicit in the purchase price. Prepare the journal entries that would be recorded for the purchase and for the payments and interest. Equipment (PV of NP + $100k down) 533,139 PVOA n= 4, I = 6% 3.46511 125,000* 3.46511 = Discount on NP 66,861 Notes payable (500,000) Cash ( $100,000) Date Cash Payment Effective Interest Discount Change in Principle Balance Outstanding Balance 12/31/2019 0.06 Reduce NP Date Cash paym Inter Diff CV inception - 433,138.75 12/31/2020 125,000.00 25,988.33 99,011.68 334,127.08 12/31/2021 125,000.00 20,047.62 104,952.38 229,174.70 12/31/2022 125,000.00 13,750.48 111,249.52 117,925.18 12/31/2023 125,000.00 7,075.51 117,924.49 - 12/31/2020 12/31/2021 12/31/2022 12/31/2023 JE at 12/31/20 JE at 12/31/21 Interest expense 25,988 Interest expense 20,048 NP 125,000 NP 125,000 Discount 25,988 Discount 20,048 Cash 125,000 Cash 125,000 SU 10.8 Troubled Debt Restructurings In a debt restructuring, the creditor grants concessions to the debtor that would not otherwise be considered. PV of the consideration paid under the restructured agreement is LESS than the carrying value of the debt (including unpaid inteerst) at the date of restructure. KNOW: accounting for both the creditor and debtor Creditor Debtor Settlement – settlement in full Records a LOSS – Difference between assets FV received and BV of the receivable (1)Records a GAIN– Difference between BV of debt and FV of consideration (2) Gain/Loss on non-monetary asset transferred between BV and FV of asset (no +/- with cash transfer) Modification Type 1 Modification of terms; New cash flows < =BV of debt Nominal/Minimum CF <= BV of Debt Decrease CV Debt Records a GAIN of the difference Nominal/Minimum CF <= BV of Debt Decrease CV Debt No future I expense – all Principle Modification Type 2 Modification of terms; New cash flows > =BV of debt Loan impairment NO gain/loss Use new interest rate for interest Expense 6

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

12.In a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should a. compute a new effective-interest rate. b not recognize a loss. c. calculate its loss using the historical effective rate of the loan. d. calculate its loss using the current effective rate of the loan. 13.Eddy Co. is indebted to Cole under a $1,000,000, 12%, three-year note dated December 31, 2019. Because of Eddy's financial difficulties developing in 2021, Eddy owed accrued interest of $120,000 on the note at December 31, 2021. Under a troubled debt restructuring, on December 31, 2021, Cole agreed to settle the note and accrued interest for a tract of land having a fair value of $900,000. Eddy's acquisition cost of the land is $725,000. Ignoring income taxes, on its 2021 income statement Eddy should report as a result of the troubled debt restructuring: Gain on Disposal Restructuring Gain a. $395,000 $0 b. $275,000 $0 c. $175,000 $100,000 d. $175,000 $220,000 What Is a Debt Covenant? A “restriction” A clause in a debt instrument contract included to protect the creditor. It describes the rights and actions of the two parties if conditions defined in the covenant occur. SU 10.9 Asset Retirement Obligations (ARO) ARO – company must recognize an ARO when it has LEGAL obligation associated with the RETIREMENT of a long-lived asset and when it can reasonably estimate the amount of the liability. Record at present value. Initiation of Asset – capitalize expected PV of retirement ( dr. Asset, cr. Long term liability @ PV ) Over time – depreciate the capital asset, accrete through interest expense the PV of the liability to face value at maturity Maturity – release the Liability when retire the asset (and incur the costs) 14.To record an asset retirement obligation (ARO), the cost associated with the ARO is a. expensed. b. included in the carrying amount of the related long-lived asset.  cap @ start, depr over the life MATCHING c. included in a separate account. d. capitalized over the asset's useful life. 15.A company buys an oil rig for $5,000,000 on January 1, 2021. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $1,000,000 (present value at 10% is $385,550) . 10% is an appropriate interest rate for this company. What expense should be recorded for 2021 as a result of these events? a. Depreciation expense of $600,000 b. Depreciation expense of $500,000 and interest expense of $38,555 c. Depreciation expense of $500,000 and interest expense of $100,000 d. Depreciation expense of $538,555 and interest expense of $38,555 7 ARO = Dep exp AND Interest exp Depr = 5m+385k ARO = 5385k/ 10 = 538,555 Int exp = End of Year 1 385,550*10% = 38,555

16.Oil products Company purchases an oil tanker depot on January 1, 2020 at a cost of $600,000 . Oil Products expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost $75,000 to dismantle the depot and remove the tanks at the end of the depot’s useful life . $75k = cost to remove in 10 years  Liabilitiy, long-term, @PV Prepare the JE to record the depot and the ARO for the depot on January 1, 2020. Based on an effective interest rate of 6%, the PV of the ARO on January 1, 2020 is $41, 879. PV$1, n=10,i=6% Depot – Fixed Asset $600,000 Cash 600,000 Depot – ARO – Fixed Asset 41, 879 ARO – Liability 41, 879 Prepare the JE for the depot and the ARO at December 31, 2020. Oil Products uses straight-line depreciation; the estimated salvage value for the depot is zero . Depot = 600k/ 10 yr = 60,000 per year… ARO –41,879/10 yr = 4,188 Depr exp 60,000 Depr exp 4,188 Total depr exp = 64,188 Accum depr 60,000 Accum Depr 4,188 Interest expense 2,513 41, 879*6% = 2,513 ARO -Liability 2,513 On December 31, 2029, Oil products pays a demolition firm to dismantle the depot and remove the tanks at a price of $80,000. Prepare the entry for the settlement of the ARO. ARO -Liability 75,000 Loss on ARO 5,000 <- change in estimate Cash 80,000 8 ARO – Liability @ inception 41, 879 End Yr 1 2,513 …@ end 75,000 (so we can resolve

SU 11 – Leases, Contingencies and Warranties SU 11.5 – Contingencies Accrual of Loss Contingency “cannot accrue for a worry” KEY: Must be a result of a PAST event! LOSS CONTINGENCY LOSS CONTINGENCY $$ AMOUNT OF POTENTIAL LOSS Likelihood Known Reasonable Estimable Not Reasonable Estimable Probable Accrue & Disclose Accrue & Disclose Disclosure Only Reasonably Possible Disclose Only Disclose Only Disclose Only Remote Nothing Nothing Nothing A loss contingency is accrued only if a loss is ____PROBABLE _______ AND the amount can be _____RESONABLY______ ______ESTIMATED________________ If there is a range, accrue the LOW the range. We __ NEVER EVER EVER EVER EVER ___ ever accrue for a gain contingency! TAKE THE BAD NOW, WAIT FOR THE GOOD Presented below are three independent situations. Prepare the Je needed as of December 31, 2020 and what should be reported in the financial statements and accompanying footnotes. 17. As a result of uninsured accidents during the year, personal injury suits for $261,000 and $697,000 have been filed against the company. It is the judgment of Starfish‘s legal counsel that an unfavorable outcome is unlikely in the $261,000 c ase but that an unfavorable verdict approximating $410,000 will probably result in the $697,000 case . Legal loss $410,000 Nothing for the $261k as it is Legal liability $410,000 “unlikely” 18. Starfish‘s deep sea exploration division consisting of operations in the Marina Trench is uninsurable because of the special risk of injury to employees and losses due to high pressure. The year 2020 is considered one of the safest (luckiest) in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of two casualties a year during the rest of the past decade (ranging from $25,000 to $1,000,000), management is certain that next year the company will probably not be so fortunate. No accrual – it does not result from a PAST transaction or event 19.Starfish Corporation owns a subsidiary in a foreign country that has a book value of $21,600,000 and an estimated fair value of $30,890,000. The foreign government has communicated to Starfish its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Starfish expects to receive 60% of the fair value of its properties as final settlement . Loss on expropriated assets 3,066,000 PROBABLE  accrue & disclose REASONABLY ESTIMATE Fv 30,890,000 *60% = 18,534,000 Bv 21,600,000 == DIFF 3,066,000 Accued liability 3,066,000 **All situations – when a loss is KNOWN, we accrue it! 9

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

SU 11.6 Warranties – a special type of Contingency **this is the perspective of the ISSUER!!** Assurance Type Warranty Included – 3 year/ 36k miles warranty Service –Type Warranty  EXTENDED **Separate performance obligation for revenue recognition Defined Specified in contract – record a liability when record the sale of the product Extended Warranty – added service beyond assurance, record separately as unearned revenue and recognize revenue on a systematic basis (S/L) over the time period How record? Matching of Rev & Exp – record warranty liability when sold Dr. Exp/ Cr. Liability Separately as unearned revenue when sold Dr Cash/ Cr. Unearned Rev Impact on I/S? Expense 100% of the expected expense when sold (in the same period) Recognize revenue on S/L basis over time ***EXPENSE THE COST TO SERVICE AS INCURRED Dr. Exp/ Cr. Cash 20. Floating Company sells hot tubs at an average price of $2,100 and also offers to each customer a separate 5-year warranty contract for $215 that requires the company to perform periodic services and to replace defective parts. During 2020, the company sold 625 hot tubs and 460 warranty contracts for cash . It estimates the 5-year warranty costs as $45 for parts and $90 for labor and accounts for warranties separately . Assume sales occurred on December 31, 2020, and straight-line recognition of warranty revenues occurs. **THIS IS A SERVICE TYPE WARRANTY/EXTENDED WARRANTY (a) Record any necessary journal entries in 2020. Cash 1,411,400 625#*$2100 = 460#*$215 = Sales Revenue 1,312,500 Unearned Rev (Warranty) 98,900 (b) In 2021, Floating incurred actual costs relative to 2020 hot tub warranty sales of $4,100 for parts and $6,800 for labor . Record any necessary journal entries in 2021 relative to 2020 hot tub warranties. Unearned Rev (Warranty) 19,780 625.00 2,100.00 1,312,500.00 460.00 215.00 98,900.00 5.00 years 19,780.00 1,411,400.00 Warranty revenue 19,780 Warranty expense 10,900 Gross Profit in 2021? Related to the Service Type warr Revneue 19,780 Exp ( 10,900) Gross profit 8,880 Inventory 4,100 Salaries payable 6,800 21.Ivanhoe provides extended service contracts on electronic equipment sold through major retailers. The standard contract is for four years . During the current year, Ivanhoe provided 41,900 such warranty contracts at an average price of $164 each . The company spent $804,000 servicing the contracts during the current year and expects to spend $4,260,000 more in the future. What is the net profit that the company will recognize in the current year related to these contracts? a. $6,067,600 b. $913,900 c. $804,000 d. $1,830,000 10 Separate performance obligation  net profit Revenue 41,900 # * $164 = 6,871,600 21.00 41,900.00 164.00 6,871,600.00 4.00 years 1,717,900.00 Rev per ye $804,000 expense 913,900.00 gp

SU 11.1 – Lease Classification **FAR 2024  only responsible for the LESSEE PERSPECTIVE!** A lease Conveys the use of an asset from one to another WITHOUT transferring of ownership. Substance over form A lease is a __ legal ____ agreement between a __ lessor ____ and a ___ lessee _____, that gives the _ lessee __ the RIGHT OF USE of specific property (PP&E) owned by the _ lessor ___, for a specified period of _ time __. Focus is on substance over form. Finance Lease Criteria ( O nly B uy T he M inimum A lways on C redit when between ages 75 - 90 ) (First 5 apply to LESSEE and LESSOR)  O wnership transfers to lessee at end of lease term OR  Purchase Option Test ( B argain) OR  T erm >= 75% of expected economic life OR  PV M inimum lease payments >= 90% of FV of asset OR  A lternative Use Test – specialized that there are no alternative uses after AND for LESSOR to be able to count as Finance Lease –(Either Sales Type/Direct Financing) NEEDS C ollectability of lease payments reasonably predictable If it is not probable, do not recognize selling profit – recognize as deposit liability! Lessor only – Direct Financing – lease includes a 3 rd party guaranteed residual value 11 LESSEE LESSOR Lease Term – noncancelable period . INCLUDE periods to extend the lease if the (1) lessee is reasonable certain to exercise that option OR (2) the option is controlled by the lessor What discount rate to use? (1)Use the implicit rate in the lease which is the r ate on the lease commence date that causes FV of leased asset to equal PV of payments [if known to lessee] **or*** (2)Lessee’s incremental borrowing rate Lease payments include – rental payments (minus incentives), plus purchase option plus penalties for terminating

FASB ASC 842 mandates that all companies will have to report both assets and related liabilities for practically all lease arrangements. LESSEE Defined Record @ Inception Ongoing Activity Finance Lease Lease transfers control (or ownership) of the underlying asset to a lessee. @ Inception of lease Dr. Right of Use Asset Cr. Lease Liability *both at PV of Min Lease Pymnts – cannot be > FV @ fiscal year end Dr. Amort Exp (Rof U Asset) Cr. Right of Use Asset (Amortize over the shorter of the lease term or the useful life of the asset) Dr. Interest Exp (on lease liability) Cr. Lease Liability When make cash payment Dr. Lease Liability Cr. Cash Operating Lease Obtains right to use asset, but not ownership @ Inception of lease Dr. Right of Use Asset Cr. Lease Liability *both at PV of Min Lease Pymnts – cannot be > FV @ fiscal year end Dr. Lease Expense  COMPROMISE!!!!! Cr. Lease Liability (Int on lease) Cr. ROU Asset (only line on I/S, equal to cash lease payments, same amount every period) When make cash payment Dr. Lease Liability Cr.Cash Short-term Lease ENOUGH! A lease that at commencement date has a lease term of 12 months OR LESS. @ Inception of lease Not carried on the Balance Sheet When make cash payment Dr. Lease Expense (expense as incurred) Cr. Cash Right of Use Asset = Lease Liability + Initial direct costs incurred by the lessee Lease Liability = PV of Lease Payments = PV of Rent Payments OR PV of Rent Payments + PV of probably owned for RV guaranteed by lessee + PV of the exercise price of a purchase option + PV of nonrenewal penalty 12 Operating Lease Lease Expense ALWAYS THE SAME = Undiscounted lease payments over term (includes initial direct costs) / years OR Interest expense on lease liability + Amortization on ROU Asset [plug]

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Lessee’s amortization of the ROU Asset Amortization of the ROU Asset is based on how it qualifies as a Finance lease Amortize over the shorter of its useful life or the lease term Ownership transfer Useful life of leased asset Bargain purchase Useful life of leased asset Term > 75 Shorter of ROU asset’s useful life or lease term Min PV > 90 Shorter of ROU asset’s useful life or lease term Alternatives NOT Shorter of ROU asset’s useful life or lease term Operating Lease Difference between single periodic lease expense and the interest expense l the lease liability recognized [plug] Inception 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31 12.31 22. Overview Example: Lease requires ten payments of $50,000 at the beginning of each year, implicit discount rate is 6%, PV of remaining lease payment is $340,000 (after 1 st payment for 1 st year) LESSEE JES If Operating Lease -L essee does NOT effectively obtain control of the asset If Finance Lease - Lessee effectively obtains control of asset Inception RofU Asset 390,000 RofU Asset 390,000 Lease liability 340,000 Lease liability 340,000 Cash 50,000 Cash 50,000 Expense at @ End of Year 1 Lease expense 50,000 Interest expense* 20,400 Lease liability* 20,400 Amort expense** 39,000 RofU Asset [PLUG!] 29,600 Lease liability* 20,400 *Inter exp 340k*6% = 20,400 Pay it!! Lease liability 50,000 Cash 50,000 RofU Asset ** 39,000 **390k/10 yr = 39,000 23.In an operating lease, the lessee records a. amortization expense. b. interest expense. c. lease expense. d. amortization expense and lease expense. 24.On December 31, 2018, Burton, Inc. leased machinery with a fair value of $ 1,575,000 from Cey Rentals Co . The agreement is a six-year noncancelable lease requiring annual payments of $300,000 beginning December 31, 2018. The lease is appropriately accounted for by Burton as a finance lease. Burton’s incremental borrowing rate is 11%. Burton knows the interest rate implicit in the lease payments is 10%. The present value of an annuity due of 1 for 6 years at 10% is 4.7908. The present value of an annuity due of 1 for 6 years at 11% is 4.6959. In its December 31, 2018 balance sheet, Burton should report a lease liability of a. $1,137,240. b. $1,275,000. c. $1,408,770. d. $1,437,240. 13 24.00 6.00 years 300,000.00 annual FINANCE lease 1.00 @ incepti interest 0.10 2.00 PVAD 4.79 3.00 includes 1st 1,437,240.00 4.00 300,000.00 5.00 1,137,240.00 6.00

25.On January 1, 2026, Lessor and Lessee sign a three year non-cancelable lease of equipment. 1. Equipment has an estimated economic life of three years. 3yr/3 yr = 100% > 75% FINANCE LEASE 2. The three lease payments are $34,972.07, each payable on January 1, 2026, 2027 and 2028. 3. The fair value of the asset at the lease commencement is $100,000. 4. Lease does not contain a renewal or purchase option and asset returns to lessor at end of the lease. 5. Asset’s residual value is $0 and there is no guaranteed residual value. 6. Lessee’s incremental borrowing rate is 5% and uses straight line method for depreciation. 7. Lessor’s implicit interest rate is 5% and is known by the lessee. 8. Initial direct costs of $800 for legal fees related the execution of the less were paid on January 1, 2026 and the lessor the lessor paid a lease incentive to the lessee of $1,200 on the same date. 1.Determine the proper lease classification on January 1, 2026. (PVAD n=3, i=5%.. 2.85941) from the lessee’s perspective. O B T75 M90 A C 3yr/3 yr = 100% > 75% FINANCE LEASE 2.Calculate the lease liability and right of use asset. Lease liability Right of use asset 3.Preare the lease liability amortization schedule and Journal entries for years 1, 2 and 3 Lease payment Interest on liability Lease Liability Net Lease Liability Jan 1, 2026-inception Jan 1, 2026 Jan 1, 2027 Jan 1, 2028 January 1, 2026  inception @ 1s payment January 1, 2027  2 nd payment Right of Use Asset 99,600 Lease liability 34,972 Cash (1200 in, 800 out) 400 34,972 Lease liability 100,000 Lease liability 34,972 Cash 34,972 December 31, 2026  accrue December 31, 2027  accrue Interest expense 3,251 Interest expense 1,665 Amortization exp* 33,200 Amortization exp* 33,200 Lease liability 3,251 Lease liability 1,665 Right of Use Asset 33,200 * 99,600/ 3 years = 33,200 Right of Use Asset 33,200 * 99,600/ 3 years = 33,200 14 25.00 Lease liab RofU Asset pay 34,972.07 800.00 Legal fees # pay 3.00 *1st pay is on inception 1,200.00 Lease incentive TO U interest 0.05 99,999.49 PV Lease PVAD 2.859410 800.00 PV of Leas 99,999.49 (1,200.00) 99,599.49 RofU Asset 0.05 Date Cash Eff inter Change Carry Value @ inception 100,000.00 @ incepti 34,972.07 - 34,972.07 65,027.93 1.1.24 34,972.07 3,251.40 31,720.67 33,307.26 1.1.25 34,972.07 1,665.36 33,306.71 0.55 <-- goal

26.On January 2, 2018, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a finance lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line amortization for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%. In its 2018 income statement, what amount of amortization expense should Hernandez report from this lease transaction? a. $300,000 b. $240,000 c. $180,000 d. $120,000 On January 1, 2018, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectability of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $6,000,000; however, the book value to Holt is $4,950,000. (c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings using the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Yancey’s incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% r ate of return. The implicit rate of the lessor is known by Yancey, Inc. (f) The yearly rental payment includes $15,000 of executory costs related to taxes on the property. The present value of an annuity due of 1 for 10 years at 10% is 6.75902 The present value of an annuity due of 1 for 10 years at 11% is 6.53705 27.What is the annual lease payment excluding executory costs? (Rounded to the nearest dollar.) a. $272,703 b. $872,703 c. $887,703 d. $902,703 28.What is the total annual lease payment? a. $272,703 b. $872,703 c. $887,703 d. $902,703 29.From the lessee’s viewpoint, what type of lease in this? a. Sales-type lease b. Sale-leaseback c. Finance lease d. Operating lease 15 Finance lease 26.00 10.00 year 300,000.00 payments 15.00 estimated life 1,800,000.00 PV 120,000.00 annual amort 27.00 10.00 years o 6,000,000.00 FV b 10.00 est life t 75 1.00 0.10 INTEREST m 90 15,000.00 EXECUTORY a 6.759020 PVAD factor 887,702.66 Annual pays 6,000,000.00 PV MLP = Fvof the asset 902,702.66 w/executory

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

30. Crane Inc. leased a new crane to Blue Construction under a 5-year, non-cancelable contract starting January 1, 2025. Terms of the lease require payments of $49,500 each January 1, starting January 1, 2025. The crane has an estimated life of 7 years, a fair value of $240,000, and a cost to Crane of $240,000. The estimated fair value of the crane is expected to be $40,000 (unguaranteed) at the end of the lease term. No bargain purchase or renewal options are included in the contract, and it is not a specialized asset. Both Crane and Blue adjust and close books annually at December 31. Collectibility of the lease payments is probable. Blue’s incremental borrowing rate is 9%, and Crane’s implicit interest rate of 9% is known to Blue. Factors At 9% Present value of 1 for 5 periods 0.64993 Present value of ordinary annuity of 1 for 5 periods 4.23972 Identify the type of lease involved. __ operating ________ Amort schedule for Rent Payment InterestLease Liability Net Lease Liability Amort schedule for Rent Payment Interest Lease Liability Net Lease Liability 1/1/25 1/1/25 12/31/25 12/31/26 12/31/27 12/31/28 Amort schedule for S/L Rent expense Interest Amort of RouA Carry Value RouA 1/1/25 12/31/25 12/31/26 12/31/27 12/31/28 12/31/29 Lessee’s Entries --Date Account Debit/ (Credit) 1/1/25 Right of Use Asset 209,866 Lease liability (209,866) Lease liability 49,500 CASH (49,500) 12/31/25 Lease expense 49,500 Right of Use Asset (35,067) Lease liability (14,433) 16

Alt Corporation enters into an agreement with Yates Rentals Co. on January 1, 2018 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement: (a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year. (b) The fair value of the machine on January 1, 2018, is $1,600,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease. (c) Alt depreciates all machinery it owns on a straight-line basis. (d) Alt’s incremental borrowing rate is 10% per year. Alt does not have knowledge of the 8% implicit rate used by Yates. The present value of an annuity due of 1 for 3 years at 8% is 2.78326 The present value of an annuity due of 1 for 3 years at 10% is 2.73554 31.What type of lease is this from Alt Corporation’s viewpoint? a. Operating lease b. Finance lease c. Sales-type lease d. Direct-financing lease 32.If Alt accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2018? a. Amortization Expense b. Lease Expense c. Interest Expense d. Amortization Expense and Interest Expense 33.If the present value of the future lease payments is $1,600,000 at January 1, 2018, what is the amount of the reduction in the lease liability for Alt Corp. in the second full year of the lease if Alt Corp. accounts for the lease as a finance lease? a. $414,852 b. $446,852 c. $472,350 d. $456,350 17

Lessee Amortize over the shorter of the lease term or the useful life of the asset Variable lease payments – payments that change over time of the lease – if we know it then we include PV in the Lease Liability. If it is unknown then expense as incur ed Amortize RofUse Asset over the shorter of the lease term or the useful life of the asset Direct Costs ( incremental costs of a lease that would not have been incurred had the lease not been executed) 18

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Week 5 (SU 10 Bonds and 11 Leases) Sp24 to present(2)

Related Documents