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Q11P_a

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Intermediate Accounting (Kieso)
Found in: Page 1248

Short Answer

(Lessee Computations and Entries, Capital Lease with Unguaranteed Residual Value) Assume the same data as in P21-10 with National Airlines having an incremental borrowing rate of 10%.

George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is $278,072, and its unguaranteed residual value at the end of the lease term is estimated to be $20,000. National will pay annual payments of $40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of $180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.

The lease is a capital lease

Initial lease liability is $270,361.

See the step by step solution

Step by Step Solution

Meaning of Lease liability

Lease liability means the amount of the lease liability in respect of any lease that would be required to be included in the statement of financial position prepared in accordance with the IFRS at the time of any determination and shall have a maturity period before the first date of such lease.

Explaining the nature of the lease in relation to the lessee

Since the lease term exceeds 75 percent of the asset's economic life (10/12 = 83 percent) and the present value of the minimum lease payments exceeds 90 percent of the leased asset's fair value, the lease is classified as a capital lease.

Computation of the amount of the initial lease liability

Initial Lease Liability:

Minimum lease payments ($40,000) X PV of an annuity due for 10 periods at 10% (6.75902

$270,361

Most popular questions for Business-studies Textbooks

Question: (Balance Sheet and Income Statement Disclosure—Lessee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017

$300,383

Residual value at end of lease term

–0–

Lessor’s implicit rate

10%

Lessee’s incremental borrowing rate

10%

Annual lease payment due at the beginning of each year, beginning with October 1, 2017

$62,700

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to $5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This $5,500 is not included in the rental payment of $62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.

Date

Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?

Receivable

Balance of Lease Liability/Receivable

10/01/17

$300,383

10/01/17

$62,700

$62,700

237,683

10/01/18

$62,700

$23,768

38,932

198,751

10/01/19

$62,700

19,875

42,825

155,926

10/01/20

$62,700

15,593

47,107

108,819

10/01/21

$62,700

10,882

51,818

57,001

10/01/22

$62,700

5,699*

57,001

0

$376,200

$75,817

$300,383

*Rounding error is $1.

Instructions

(a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement.

(3) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2019?

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