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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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Determining Type of Lease and Subsequent Accounting On January 1, 2019, Alice Company leases nonspecialized equipment for 5 years, agreeing to pay $65,000 annually at the beginning of each year under the noncancelable lease. Superior Equipment Company, the lessor, agrees to remit all executory costs, estimated to be $3,450 per year. The cost of the equipment is $275,000 and the fair value of the equipment is $305,000. Its estimated life is 10 years. The estimated residual value at the end of 5 years is $75,000 and is not guaranteed by Alice; at the end of 10 years, it is $5,000. There is no bargain purchase option in the lease or any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. On October 1 of each war, Superior Equipment pays property taxes of $650, maintenance costs of $1,600, and insurance of $1,200. Due to recent cash flow problems, Superior believes that Alice may not be able to make all of the required lease payments. Straight-line depreciation is considered the appropriate method by both companies.

Required:

  1. 1. Next Level Identify the type of lease involved for Alice and Superior Equipment and give reasons for your classifications.
  2. 2. Prepare appropriate journal entries for 2019 for the lessee and lessor.
  3. 3. Next Level Assume that the residual value is guaranteed by Alice, and Alice believes the probable payment under this guarantee is $75,000. Identify the type of lease and briefly explain why. Assume the executory costs are included in the amount of the lease payments. Prepare journal entries for 2019 and 2020 for the lessee and lessor.

1.

To determine

Identify the type of the lease between Company A and Company S and give the reasons for such classification.

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’.

Identify the type of the lease between Company A and Company S:

CriteriaMet or notRemarks
1.Transfer of ownership at the end of leaseNo
2.Bargain purchase optionNo
3.Lease term is for major part of its economic lifeNo50% (5 years/10 years)
4.Present value of lease payments is substantially all of the fair valueNo

PV 86% of fair value

($262,427.69/$305,000)

5. Specializes nature of the assetNo 
Additional criteria (For lessor)  
1. Present value of lease payments and any guaranteed residual value equals or exceeds substantially all of the fair valueNo

PV 86% of fair value

($262,427

2.

To determine

Prepare the appropriate journal entries in the books of the lessor and lessee companies for the year 2019.

3.

To determine

Identify the type of lease in the event of the residual value at the end of 5 years lease period is guaranteed by the Company A, the lessee and. Prepare journal entry for the lessee and the lessor for 2019, 2020, and when the lessee pays the guaranteed residual value.

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