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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Lessee Accounting with Payments Made at Beginning of Year Adden Company signs a lease agreement dated January 1, 2019, that provides for it to lease non-specialized heavy equipment from Scott Rental Company beginning January 1, 2019. The lease terms, provisions, and related events are as follows:

  1. 1. The lease term is 4 years. The lease is noncancelable and requires annual rental payments of $20,000 to be paid in advance at the beginning of each year.
  2. 2. The cost, and also fair value, of the heavy equipment to Scott at the inception of the lease is $68,036.62. The equipment has an estimated life of 4 years and has a zero estimated residual value at the end of this time.
  3. 3. Adden agrees to pay all executory costs directly to a third party.
  4. 4. The lease contains no renewal or bargain purchase options.
  5. 5. Scott’s interest rate implicit in the lease is 12%. Adden is aware of this rate, which is equal to its borrowing rate.
  6. 6. Adden uses the straight-line method to record depreciation on similar equipment.
  7. 7. Executory costs paid at the end of the year by Adden are:

Chapter 20, Problem 2E, Lessee Accounting with Payments Made at Beginning of Year Adden Company signs a lease agreement

Required:

  1. 1. Next Level Determine what type of lease this is for Adden.
  2. 2. Prepare a table summarizing the lease payments and interest expense for Adden.
  3. 3. Prepare journal entries for Adden for the years 2019 and 2020.

1.

To determine

Identify the type of lease for the lessee.

Explanation

Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.

Operating leases: In an operating lease lessor retains all ownership risks and responsibilities.

Finance leases: In finance lease all the ownership risks and responsibilities are transferred from the lessor to the lessee.

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:

    1. Transfer of ownership: The asset is transferred to lessee at the end of the lease period concerned.

    2. Purchase (bargain) option: The purchase option is exercisable when the purchase price is sufficiently lower than expected fair value.

    3. Economic life: The economic life of the lease period is 75% or more than the useful life of the asset.

    4. 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 fulfil any of the above four criteria, it would be considered as operating lease.

Identify whether the given lease qualifies as an operating lease or finance lease:

Criteria for classificationWhether criteria met or notRemarks
1...

2.

To determine

Prepare a table to summarize the lease payment and interest expenses.

3.

To determine

Prepare journal entries for the years 2019 and 2020.

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