(Lessor and Lessee Accounting and Disclosure) Sylvan Inc. entered into a noncancelable lease arrangement with Breton Leasing Corporation for a certain machine. Breton’s primary business is leasing; it is not a manufacturer or dealer. Sylvan will lease the machine for a period of 3 years, which is 50% of the machine’s economic life. Breton will take possession of the machine at the end of the initial 3-year lease and lease it to another, smaller company that does not need the most current version of the machine. Sylvan does not guarantee any residual value for the machine and will not purchase the machine at the end of the lease term.
Sylvan’s incremental borrowing rate is 10%, and the implicit rate in the lease is 9%. Sylvan has no way of knowing the implicit rate used by Breton. Using either rate, the present value of the minimum lease payments is between 90% and 100% of the fair value of the machine at the date of the lease agreement.
Sylvan has agreed to pay all executory costs directly, and no allowance for these costs is included in the lease payments. Breton is reasonably certain that Sylvan will pay all lease payments. Because Sylvan has agreed to pay all executory costs, there are no important uncertainties regarding costs to be incurred by Breton. Assume that no indirect costs are involved.
(a) With respect to Sylvan (the lessee), answer the following.
The lease is a capital lease.
The transfer of ownership rights from one party to another at the completion of the lease period is term as a capital lease. A lessee might benefit from capital leasing by purchasing an asset at a lower cost than the market value.
Sylvan should record this as a capital lease since the present value of the minimum lease payments is higher than 90% of the asset's fair value at the start of the lease.
Assume that on January 1, 2017, Elmer’s Restaurants sells a computer system to Liquidity Finance Co. for $680,000 and immediately leases the computer system back. The relevant information is as follows.
Prepare the journal entries for both the lessee and the lessor for 2017 to reflect the sale and leaseback agreement. No uncertainties exist, and collectibility is reasonably certain.
(Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for $900,000 by Young Co. The machine is expected to have an 8-year life with no salvage value. It is to be depreciated on a straight-line basis. The machine was leased to St. Leger Inc. on January 1, 2017, at an annual rental of $210,000. Other relevant information is as follows.
(b) What amount should St. Leger Inc. report for rent expenses for 2017 on this lease?
Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston’s specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of $413,971 each January 1, starting January 1, 2017.
Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is $2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.
(f) Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2017, for both the lessee and the lessor.
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.
October 1, 2017
Economic life of leased equipment
Fair value of asset at October 1, 2017
Residual value at end of lease term
Lessor’s implicit rate
Lessee’s incremental borrowing rate
Annual lease payment due at the beginning of each year, beginning with October 1, 2017
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.
Annual lease payments/Receipt
On Unpaid liability/Receivable
Reduction of Lease Liability?
Balance of Lease Liability/Receivable
*Rounding error is $1.
(b) Assuming the lessee’s accounting period ends on December 31, answer the following questions with respect to this lease agreement.
(1) What items and amounts will appear on the lessee’s income statement for the year ending December 31, 2017?
(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.
(b) Prepare the journal entries that Wise Inc. should make in 2017
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