INTERMEDIATE ACCOUNTING
INTERMEDIATE ACCOUNTING
8th Edition
ISBN: 9780078096488
Author: SPICELAND
Publisher: MCG
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Chapter 15, Problem 15.18P

1)

To determine

Sales-type lease

Sales type is a parallel type of direct financing whereby the owner (lessor) purchases the equipment to lease it and received the interest revenue over the period of lease for equipment, apart from the recognition of profit from sale of equipment.

The criteria for defining the lease as finance lease or operating lease

As per the notes issued by Financial Accounting Standard Board (FASB), the following are four criteria to determine is a lease is a capital lease or an operating lease:

  • Transfer of title: The asset is transferred to lessee at the end of the lease period concerned.
  • Purchase option: The purchase option is exercisable when the purchase price is sufficiently lower than expected fair value.
  • Economic life: The economic life of the lease period is 75% or more than the useful life of the asset.
  • Value recovery: Present value of lease payments is greater or equal to 90% of the fair value.

If a particular lease fulfils any one of the above four criteria, then it is considered as finance lease. If a lease does not fulfill any of the above four criteria, it would be considered as operating lease.

Initial direct cost

Initial direct cost refers to the cost that

  1. (a) Related directly with the completing a lease agreement
  1. (b) Important for acquiring a lease
  1. (c) Would not have been incurred had the lease agreement not occurred.

To Classify: the type of lease by BL company (Lessor) and by RB Company (Lessee)

1)

Expert Solution
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Explanation of Solution

BL Company (Lessor)

Here at least one (Two in this scenario) classification criterion are met, this is a capital lease. As the fair value is the lessor’s cost, also no selling profit, in this sales type lease.

RB Company (Lessee)

Since at least one (Two in this scenario) criteria are met, this is capital lease to the lessee. The lessee records the present value of lease payments as right-of-use asset and lease payable.

S.No Classification criteria Does it satisfy?
1 Does the lease agreement specify about ownership transfer? No  
2 Does the lease agreement state about bargain purchase option? No  
3 Does the term of lease constitute major part of the expected economic life of the asset? Yes Lease term = 8 years
Useful life = 8 years
4 Is the present value of lease payments greater than or equal to substantially (90%) all of the market/fair value of the asset? Yes Present value (1) = $645,526
Fair value = $645,526
5 Is the asset is of such a specialized nature which is expected to have an alternative use to lessor at the end of the term of lease? No  

Table (1)

Working note:

The present value of lease payments is calculated as below:

Present value of lease payments} =Annual lease payments×PVIFA (10%,8)=$110,000×5.86842=$645,526 (1)

(2)

To determine

To Prepare: the appropriate entries for RB Company (Lessee) and BL Company (Lessor) on January 01, 2016.

(2)

Expert Solution
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Explanation of Solution

Prepare journal entries for RB Company (Lessee)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2016        
January 01 Right-of-use asset (1)   645,526  
  Lease Payable     26,427
  (To record the lease payable)      
         
January 01 Lease payable   110,000  
  Cash     110,000
  (To record the quarterly lease payments)      

Table (2)

Prepare journal entries for BL Company (Lessor)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2016        
January 01 Lease Receivable   645,526  
  Equipment     645,526
  (To record the lease receivable)      
         
January 01 Lease receivable   18,099  
  Cash     18,099
  (To record the initial direct cost)      
         
January 01 Cash   110,000  
  Lease receivable     110,000
  (To record the lease payments received)      

Table (3)

(3)

To determine

To Prepare: amortization schedule for RB Company (Lessee)

(3)

Expert Solution
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Explanation of Solution

Prepare amortization schedule as follows:

Lease Amortization Schedule
A B C D E
Date Lease Payment ($) Effective Interest (10% × Outstanding balance) ($)

Payment Reduction ($)

(B –C)

Outstanding Balance ($)

(E –D)

        645,526
1/1/2016 110,000   110,000 535,526
12/31/2016 110,000 53,553 56,447 479,079
12/31/2017 110,000 47,908 62,092 416,986
12/31/2018 110,000 41,699 68,301 348,685
12/31/2019 110,000 34,869 75,131 273,554
12/31/2020 110,000 27,355 82,645 190,909
12/31/2021 110,000 19,091 90,909 100,000
12/31/2022 110,000 10,000 100,000 0
  880,000 234,474 645,526  

Table (4)

The amortization table is prepared to present the pattern of interest expenses throughout the period. The schedule shows the lease balance and effective interest change over the 8- term period of lease using effective interest rate of 10%. Each lease payment after the first payment includes both the interest and amount that represents the reduction of outstanding balance. At the end of the lease period, the outstanding balance becomes zero.

(4)

To determine

the effective rate of interest for BL Company (Lessor) for the purpose of recognizing interest revenue over the lease term.

(4)

Expert Solution
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Explanation of Solution

First, calculate the net investment.

The net investment is higher: $645,526 + $18,099 = $663,625

Net investment = Fair value + Initial direct cost= $645,526 + $18,099= $663,625

Then, calculate the present value table amount from the given data:

Present value annuity amount} = Net investmentAnnual lease payment$663,625$110,000= 6.03295

Now, match the present value annuity with the rates of interest in the present value annuity table to ascertain the applied rate of interest.

When matching the present value annuity amount (6.03295) with the annuity table, we could find that the value 6.03295 falls in 8 years column under 9% rate of interest.

Therefore, effective rate of interest is 9%

(5)

To determine

To Prepare: amortization schedule for BL Company (Lessor)

(5)

Expert Solution
Check Mark

Explanation of Solution

Prepare amortization schedule as follows:

Lease Amortization Schedule
A B C D E
Date Lease Payment ($) Effective Interest (9% × Outstanding balance) ($)

Payment Reduction ($)

(B –C)

Outstanding Balance ($)

(E –D)

        663,625
1/1/2016 110,000   110,000 553,625
12/31/2016 110,000 49,826 60,174 493,451
12/31/2017 110,000 44,411 65,589 427,862
12/31/2018 110,000 38,508 71,492 356,369
12/31/2019 110,000 32,073 77,927 278,443
12/31/2020 110,000 25,060 84,940 193,503
12/31/2021 110,000 17,415 92,585 100,918
12/31/2022 110,000 9,083 100,917 0
  880,000 216,375 663,625  

Table (5)

The amortization table is prepared to present the pattern of interest expenses throughout the period. The schedule shows the lease balance and effective interest change over the 8- term period of lease using effective interest rate of 9%. Each lease payment after the first payment includes both the interest and amount that represents the reduction of outstanding balance. At the end of the lease period, the outstanding balance becomes zero.

(6)

To determine

To Prepare: appropriate entries for RB Company (Lessee) and BL Company (Lessor) as on December 31, 2016. (Second lease payments)

(6)

Expert Solution
Check Mark

Explanation of Solution

Prepare journal entries for RB Company (Lessee)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2016        
December 31 Amortization expense (2)   80,691  
         Right-of-use asset     80,691
  (To record amortization expense.)      
         
December 31 Interest expense (From table 4)   53,553  
  Lease payable   56,447  
  Cash     110,000
  (To record the lease payments and interest expense)      

Table (6)

Working note:

Calculate the amortization expense for the asset

Amortization expense = Present value of lease paymentsLease term=$645,5268=$80,691 (2)

Prepare journal entries for BL Company (Lessor)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2016        
December 31 Cash   110,000  
      Lease receivable     60,174
      Interest revenue (From table 5)     49,826
  (To record interest revenue.)      

Table (7)

(7)

To determine

To Prepare: appropriate entries for RB Company (Lessee) and BL Company (Lessor) as on December 31, 2022. (Final lease payments)

(7)

Expert Solution
Check Mark

Explanation of Solution

Prepare journal entries for RB Company (Lessee)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2022        
December 31 Amortization expense (2)   80,691  
         Right-of-use asset     80,691
  (To record amortization expense.)      
         
December 31 Interest expense (From table 4)   10,000  
  Lease payable   100,000  
  Cash     110,000
  (To record the lease payments and interest expense)      

Table (8)

Prepare journal entries for BL Company (Lessor)

Date Account Title and Explanation Post Ref Debit ($) Credit ($)
2022        
December 31 Cash   110,000  
      Lease receivable     100,918
      Interest revenue (From table 5)     9,082
  (To record interest revenue.)      

Table (9)

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Chapter 15 Solutions

INTERMEDIATE ACCOUNTING

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