Tutorial Solution Lease Lessess

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PROBLEM 21.

The lessee determines the lease liability as follows.

For purposes of measuring the initial lease liability, only amounts


expected to be owed under the residual value guarantee should be
included. That is, only the present value of the difference between the
residual value guarantee and the expected residual value at the end of
the lease term should be included.

£ 113,864 Annual rental payment


X 4.99271 PV of an annuity-due of 1 for n = 6, i = 8%
£ 568,490 PV of periodic rental payments

£ 5,000 Amount expected to be owed under residual value


guarantee
($50,000 – $45,000)
X .63017 PV of 1 for n = 6, i = 8%
£ 3,151 PV of guaranteed residual value
$ 568,490 PV of periodic rental payments
+ 3,151 PV of guaranteed residual value
£ 571,641 PV of lease payments

(a) VANCE PLC (Lessee)


Lease Amortization Schedule

Annual
Lease Reduction
Payment Interest (8%) of Lease Lease
Date Plus GRV on Liability Liability Liability
1/1/19 £571,641
1/1/19 £113,864 £ –0– £113,864 457,777
1/1/20 113,864 36,622 77,242 380,535
1/1/21 113,864 30,443 83,421 297,114
1/1/22 113,864 23,769 90,095 207,019
1/1/23 113,864 16,562 97,302 109,717
1/1/24 113,864 8,777 105,087 4,630
12/31/24 5,000 370 4,630 0
£688,184 £116,543 £571,641
PROBLEM 21.1 (Continued)

(b) January 1, 2019


Right-of-Use Asset.................................................. 571,641
Lease Liability...................................................
571,641

Lease Liability.......................................................... 113,864


Cash...................................................................
113,864

December 31, 2019


Interest Expense...................................................... 36,622
Lease Liability...................................................
36,622

Depreciation Expense............................................. 95,274


Right-of-Use Asset (£571,641 ÷ 6)...................
95,274

January 1, 2020
Lease Liability.......................................................... 36,622
Interest Expense...............................................
36,622

Interest Expense...................................................... 36,622


Lease Liability.......................................................... 77,242
Cash...................................................................
113,864

December 31, 2020


Interest Expense...................................................... 30,443
Lease Liability...................................................
30,443

Depreciation Expense............................................. 95,274


Right-of-Use Asset...........................................
95,274

Note to instructor: The guaranteed residual value is not


subtracted from the right-of-use asset for purposes of
determining the amortizable base. This reflects the intangible
nature of the right-of-use asset. The lessee records as a right-of-
use asset only the amount of the fair value of the asset it intends
to use up throughout the course of the lease term. The return of
the asset to the lessor is not considered a benefit to the lessee, and
thus should not be included in the right-of-use asset. The right-of-
use asset should be amortized to zero, as all of its benefit is realized
through the asset’s use.
PROBLEM 21.1 (Continued)

(c) A lease incentive does not impact the measurement of the lease
liability. However, a reduction in the right-of-use asset must be made.
Thus, the right-of-use asset would be measured at £566,641 (£571,641
– £5,000).

The prepayment of rent by the lessee should be recorded as an asset


in the form of an increased right-of-use asset. Therefore, the right-of-
use asset would initially be measured at £576,641 (£571,641 + £5,000).

LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.2

(a) The $550,000 is the present value of the five annual lease
payments of $120,987 to be made at the beginning of each year
discounted at 5% since the lessee knows the implicit rate.

(b) Right-of-Use Asset.................................................. 550,000


Lease Liability...................................................
550,000
($120,987 X Present value of annuity-due
factor for 5 years at 5% : $120,987 X
4.54595 = $550,000*)

*Rounded.

Lease Liability.......................................................... 120,987


Cash...................................................................
120,987

(c) Depreciation Expense............................................. 220,000


Right-of-Use Asset...........................................
220,000
($550,000 X 40% = $220,000)

Interest Expense...................................................... 21,451


Lease Liability...................................................
21,451
 (See amortization schedule)

(d) Lease Liability.......................................................... 120,987


Cash...................................................................
120,987

CAGE COMPANY (Lessee)


Lease Amortization Schedule (partial)
Annual Reduction
Lease Interest (5%) of Lease Lease
Date Payment on Liability Liability Liability
1/1/19 $550,000
1/1/19 $120,987 $ –0– $120,987 429,013
1/1/20 120,987 21,451 99,536 329,477
1/1/21 120,987 16,474 104,513 224,964
PROBLEM 21.2 (Continued)

(e) CAGE COMPANY


Statement of Financial Position (Partial)
December 31, 2019

Assets Liabilities
Non-current assets: Current:
Right-of-use Asset $330,000 Lease liability $120,987*

Noncurrent:
Lease liability $329,477**

*The current portion of the lease liability will contain a component for the accrued
interest expense to be paid on the lease liability ($429,013 X 5% = $21,451) plus a
component for the reduction of the original lease liability ($120,987 – $21,451 =
$99,536).
**See amortization schedule from part (d).

(f) Insurance payments are an executory cost. Assuming a gross


lease, the insurance payments must be included in the present value
of the lease payments when initially valuing the lease liability.
Therefore, the initial liability would be measured as follows:

Present value of rental payments (see part b)...... $550,000


Present value of insurance payments
($2,000 X 4.54595*)............................................... 9,092
Lease Liability.......................................................... $559,092

* PV of an annuity-due of $1 for 5 periods at 5%.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

PROBLEM 21.4

Entries on August 1, 2019:

(1) Right-of-Use Asset.............................................. 4,119,480


Lease Liability...............................................
4,119,480

The leased computer and the related liability are recorded at the
present value of the lease payments as follows: $40,000 X 102.987 =
$4,119,480.

(2) Lease Liability.................................................... 40,000


Cash.............................................................
40,000

Explanation: This entry is to record the August 1, 2019, first


payment under the lease agreement. No interest is recognized on
August 1 because the agreement began on that date, and no time
as elapsed.

Entries on August 31, 2019:

(1) Interest Expense................................................ 20,397


Lease Liability.............................................
20,397

Explanation and computation: Interest accrued on the unpaid


balance of the lease liability from August 1 to August 31, 2019, is
computed as follows: ($4,119,480 – $40,000) X .005 = $20,397.

(2) Depreciation Expense....................................... 28,608


Right-of-Use Asset.....................................
28,608

Explanation and computation: Amortization is recorded for one


month of the use of computer using the lease term: ($4,119,480 ÷
12) X 1/12 = $28,608.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

PROBLEM 21.8

(a)
For purposes of measuring the initial lease liability, only probable
amounts expected to be owed under the residual value guarantee
should be included. That is, only the present value of the
difference between
the residual value guarantee and the expected residual value at
the end of the lease term should be included. The calculation of
the initial value of the lease liability is as follows:

PV of Lease Liability:
PV of rental payments, R$60,000 X 8.10782.....................
R$486,469
PV of guaranteed residual expected to be owed
[(R$15,000 – R$10,000) X .61391]..................................
3,070
Initial lease liability.............................................................
R$489,539
PROBLEM 21.8 (Continued)

(b) CHAMBERS MEDICAL (Lessee)


Lease Amortization Schedule
(Annuity-Due Basis, GRV)

Annual Lease Interest (5%) Reduction


Beginning Payment Plus on Unpaid of Lease Lease
of Year GRV Liability Liability Liability
(a) (b) (c) (d)
Initial PV R$489,539
1 R$ 60,000 R$ 0 R$ 60,000 429,539
2 60,000 21,477 38,523 391,016
3 60,000 19,551 40,449 350,567
4 60,000 17,528 42,472 308,095
5 60,000 15,405 44,595 263,500
6 60,000 13,175 46,825 216,675
7 60,000 10,834 49,166 167,509
8 60,000 8,375 51,625 115,884
9 60,000 5,794 54,206 61,678
10 60,000 3,084 56,916 4,762
End of 10 5,000 238 4,762 0
R$605,000 R$115,461 R$489,539

(a) Annual lease payments and amount expected to be owed under


residual value guarantee.
(b) Preceding balance of (d) X 5%, except beginning of first year of lease
term.
(c) (a) minus (b).
(d) Preceding balance minus (c).

(c) Lessee’s journal entries:

Beginning of the Year


Right-of-Use Asset.................................................. 489,539
Lease Liability...................................................
489,539
(To record the lease of x-ray equipment
using finance lease method)
Lease Liability.......................................................... 60,000
Cash...................................................................
60,000
(To record payment of annual lease
obligation)

PROBLEM 21.8 (Continued)

End of the Year


Interest Expense...................................................... 21,477
Lease Liability...................................................
21,477
(To record accrual of annual interest on
lease obligation)

Amortization Expense............................................. 48,954


Right-of-Use Asset...........................................
48,954
(To record amortization expense for
year 1 using straight-line method
[R$489,539 ÷ 10 years])

Note to instructor: The guaranteed residual value is not


subtracted from the right-of-use asset for purposes of
determining the amortizable base. This reflects the intangible
nature of the right-of-use asset. The lessee records as a right-of-
use asset only the amount of the fair value of the asset it intends
to use up throughout the course of the lease term. The return of
the asset to the lessor is not considered a benefit to the lessee, and
thus should not be included in the right-of-use asset. The right-of-
use asset should be amortized to zero, as all of its benefit is realized
through the asset’s use.

(d) The document preparation costs are considered initial direct


costs. As such, they will impact the initial measurement of the right-
of-use asset, but will not affect the lease liability. The right-of-use
asset must be increased as a result of any initial direct costs incurred.
Therefore, under the new circumstances, the initial measurement of
the right-of-use asset would be R$496,539 (R$489,539 + R$7,000).
LO: 2, 4, Bloom: AP, Difficulty: Complex, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.10

(a) Initial Lease Liability:


Lease payments (¥40,000) X PV of an
annuity-due for 10 periods at 8% (7.24689)..................
¥289,876

(b) JAL (Lessee)


Lease Amortization Schedule
(Annuity-due basis and URV)

Interest (8%) Reduction


Beginning Annual Lease on Lease of Lease Lease
of Year Payment Liability Liability Liability
(a) (b) (c) (d)
Initial PV — — — ¥289,876
1 ¥ 40,000 — ¥ 40,000 249,876
2 40,000 ¥ 19,990 20,010 229,866
3 40,000 18,389 21,611 208,255
4 40,000 16,660 23,340 184,915
5 40,000 14,793 25,207 159,708
6 40,000 12,777 27,223 132,485
7 40,000 10,599 29,401 103,084
8 40,000 8,247 31,753 71,331
9 40,000 5,706 34,294 37,037
10 40,000 2,963 37,037 0
¥400,000 ¥110,124 ¥289,876

(a) Annual lease payment required by lease contract.


(b) Preceding balance of (d) X 8%, except beginning of first year of lease
term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
PROBLEM 21.10 (Continued)

(c) Lessee’s journal entries:

Beginning of the Year


Right-of-Use Asset.................................................. 289,876
Lease Liability...................................................
289,876
(To record the lease of computer
equipment using finance lease method)

Lease Liability.......................................................... 40,000


Cash...................................................................
40,000
(To record the first rental payment)

End of the Year


Interest Expense...................................................... 19,990
Lease Liability...................................................
19,990
(To record accrual of annual interest on
lease liability)

Depreciation Expense............................................. 28,988


Right-of-Use Asset...........................................
28,988
(To record amortization expense for
first year [¥289,876 ÷ 10])
LO: 2, Bloom: AP, Difficulty: Complex, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None

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