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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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Accounting for Leases by Lessee and Lessor Scupper Farms, the lessee, and Tyrrell Equipment, the lessor, sign a lease agreement on January 1, 2019, that provides for Scupper to lease a cultivator from Tyrrell. The lease terms, provisions, and other related events are as follows:

  • The lease is noncancelable and has a term of 6 years.
  • The annual rentals are $55,000 payable at the beginning of each year.
  • Scupper agrees to pay all executory costs directly to a third party, which are expected to be $1,100 annually, including property taxes of $500, insurance of $350, and maintenance of $250. These costs are paid each year on November 1.
  • The cultivator has an estimated economic life of 6 years.
  • Scupper guarantees a residual value of $60,000 at the end of 6 years. Scupper believes it is probable that it will pay $15,000 cash as a result of this guarantee.
  • The interest rate implicit in the lease is 14%, which is known by Scupper.
  • Scupper’s incremental borrowing rate is 15%, and it uses the sum-of-the years’ digits method to record depreciation on similar equipment.
  • The cost of the cultivator is $250,000.00. The fair value of the cultivator to Tyrrell is $271,154.68.
  • The lessor incurs no material initial direct costs.
  • Tyrell expects to collect all lease payments from Scupper.

Required:

  1. 1. Next Level Identify the type of lease involved for both Scupper and Tyrrell and give reasons for your classifications.
  2. 2. Prepare the journal entries for both Scupper and Tyrrell for 2019.

1.

To determine

Identify the lease type that involved for both Company S and Company T and give the reasons for the 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’.

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

A lease is considered as a finance lease if it met at least one of the four capitalization criteria and two recognition criteria. In this case, examine if the lease agreement between the Company S and Company T meet the capitalization criteria as follows:

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 lifeYes100% (6 years/6 years)
4.Present value of lease payments is substantially all of the fair valueYes100% ($271,154.68/$271,154.68)
5

2.

To determine

Prepare the journal entries for both Company S and Company T for 2019.

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