George Dairy leases its milking equipment from King Finance Company under the following lease provisions. 1. The lease term is 10 years, non-cancelable, and requires equal rental payments of $30,300 due at the beginning of each year starting January 1, 2019. 2. The equipment has a fair value at the commencement of the lease (January 1, 2019) of $242,741 and a cost of $180,000 on King Finance's books. It also has an estimated economic life of 15 years and an expected residual value of $45,000, though George Dairy has guaranteed a residual value of $50,000 to King Finance. 3. The lease contains no renewal options, and the equipment reverts to King Finance upontermination of the lease. The equipment is not of a specialized use. 4. George Dairy's incremental borrowing rate is 6% per year. King Finance earns 8% rate of returns on its investment, which is known by George Dairy. 5. George Dairy depreciates similar equipment that it owns on a straight-line basis. 6. Collectibility of the payments is probable. Present value of an annuity-due of 1 for 10 periods at 8% is 7.24689; Present value of a single-sum of 1 for 10 periods at 8% is 0.46319; Present value of an annuity-due of 1 for 10 periods at 6% is 7.80169; Present value of a single-sum of 1 for 10 periods at 6% is 0.55839. Instructions a. Evaluate the criteria for classification of the lease by the lessor, and identify the nature of the lease. b. Prepare the journal entries for the lessee and lessor at January 1, 2019, and December 31, 2019 (the lessee's and lessor's year-end). c. What would have been the amount of the initial lease liability recorded by the lessee upon the commencement of the lease, assuming the residual value of $50,000 had not been guaranteed at all?
George Dairy leases its milking equipment from King Finance Company under the following lease provisions.
1. The lease term is 10 years, non-cancelable, and requires equal rental payments of $30,300 due at the beginning of each year starting January 1, 2019.
2. The equipment has a fair value at the commencement of the lease (January 1, 2019) of $242,741 and a cost of $180,000 on King Finance's books. It also has an estimated economic life of 15 years and an expected residual value of $45,000, though George Dairy has guaranteed a residual value of $50,000 to King Finance.
3. The lease contains no renewal options, and the equipment reverts to King Finance upontermination of the lease. The equipment is not of a specialized use.
4. George Dairy's incremental borrowing rate is 6% per year. King Finance earns 8%
5. George Dairy
6. Collectibility of the payments is probable.
Present value of an annuity-due of 1 for 10 periods at 8% is 7.24689;
Present value of a single-sum of 1 for 10 periods at 8% is 0.46319;
Present value of an annuity-due of 1 for 10 periods at 6% is 7.80169;
Present value of a single-sum of 1 for 10 periods at 6% is 0.55839.
Instructions
a. Evaluate the criteria for classification of the lease by the lessor, and identify the nature of the lease.
b. Prepare the
c. What would have been the amount of the initial lease liability recorded by the lessee upon the commencement of the lease, assuming the residual value of $50,000 had not been guaranteed at all?
d. On the lessor's books, what changes would occur to the accounting treatment at the commencement of the lease, assuming the residual value of $50,000 had not been guaranteed at all?
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