Brief Exercise 21A-2
Pharoah Co. processes jam and sells it to the public. Pharoah leases equipment used in its
production processes from Shamrock, Inc. This year, Pharoah leases a new piece of equipment
from Shamrock. The lease term is 5 years and requires equal rental payments of $19,000 at the
beginning of each year. In addition, there is a renewal option to allow Pharoah to keep the
equipment one extra year for a payment at the end of the fifth year of $12,000 (which Pharoah is
reasonably certain it will exercise). The equipment has a fair value at the commencement of the
lease of $91,913 and an estimated useful life of 7 years. Shamrock set the annual rental to earn a
rate of return of 7%, and this fact is known to Pharoah. The lease does not transfer title, does not
contain a bargain purchase option, and the equipment is not of a specialized nature.
How should Pharoah classify this lease?
Pharoah should classify the lease as a/an
finance
lease.
~The lease does not meet the transfer of ownership test, the bargain purchase test, or the
specialized asset test. While the initial five-year lease term and rental payments would result in the
lease failing the economic life test and the present value test, Pharoah must also take the renewal
option into account when computing the lease term and present value of the lease payments, as the
exercise of the renewal option is reasonably certain. When accounting for the bargain renewal
option, the lease will in fact meet both the economic life test and the present value test (as shown
below). Thus, the lease should be classified as a finance lease for Pharoah Co.
Economic Life Test
6 years (5 years initial + 1 year for renewal option) ÷ 7 years = 85.7% > 75%
Present Value Test
PV of initial rental payments (4.38721* × $19,000):
$83,357
PV of bargain renewal option (0.71299** × $12,000):
8,556
PV of lease payments:
$91,913
Fair value of the equipment:
÷ 91,913
PV of lease payments as a percent of fair value
100 %
*Present value of an annuity due of 1 for 5 periods at 7%.
**Present value of 1 for 5 periods at 7%.
Brief Exercise 21A-3
Larkspur Company leases a building and land. The lease term is 6 years and the annual fixed
payments are $880,000. The lease arrangement gives Larkspur the right to purchase the building
and land for $14,000,000 at the end of the lease. Based on an economic analysis of the lease at the
commencement date, Larkspur is reasonably certain that the fair value of the leased assets at the
end of lease term will be much higher than $14,000,000.
What are the total lease payments in this lease arrangement?
Total lease payments $19,280,000
~The lease payments in the lease arrangement will include both the annual fixed payments of
$880,000 each year, plus the $14,000,000 bargain purchase option at the end of the lease term (as
it is reasonably certain to be exercised). Thus, the lease payments for the lease agreement total
($880,000 × 6) + $14,000,000 = $19,280,000.
Brief Exercise 21A-6
Marin Company leased equipment from Costner Company, beginning on December 31, 2016.
The lease term is 8 years and requires equal rental payments of $51,574 at the beginning of each
year of the lease, starting on the commencement date (December 31, 2016). The equipment has a
fair value at the commencement date of the lease of $350,000, an estimated useful life of 8 years,
and no estimated residual value. The appropriate interest rate is 5%.
Prepare Marin’s 2016 and 2017 journal entries, assuming Marin depreciates similar equipment it
owns on a straight-line basis. (Credit account titles are automatically indented when the amount is
entered. Do not indent manually. For calculation purposes, use 5 decimal places as displayed in
the factor table provided and round final answers to 0 decimal places, e.g. 5,275.)
Date
12/31/16
Account Titles and Explanation
enter an account title To record lease liability on
December 31 2016
Right-of-Use Ass
enter an account title To record lease liability on
December 31 2016
Debit
enter a debit
amount
Credit
enter a credit
amount
350,000
enter a debit
amount
Lease Liability
enter a credit
amount
350,000
(To record lease liability)
12/31/16
enter an account title To record lease payment on
December 31 2016
Lease Liability
enter an account title To record lease payment on
December 31 2016
enter a debit
amount
enter a credit
amount
51,574
enter a debit
amount
enter a credit
amount
Cash
51,574
(To record lease payment)
enter an account title To record interest expense
12/31/17 on December 31 2017
Lease Liability
enter an account title To record interest expense
on December 31 2017
Interest Expense
enter an account title To record interest expense
on December 31 2017
enter a debit
amount
enter a credit
amount
36,653
enter a debit
amount
enter a credit
amount
14,921
enter a debit
amount
Cash
enter a credit
amount
51,574
(To record interest expense)
enter an account title To record amortization of
12/31/17 the right-of-use asset on December 31 2017
Amortization Exp
enter an account title To record amortization of
the right-of-use asset on December 31 2017
enter a debit
amount
enter a credit
amount
43,750
enter a debit
amount
Right-of-Use Ass
enter a credit
amount
43,750
(To record amortization of the right-of-use asset)
~
12/31/16 Right-of-Use Asset
= $51,574 × 6.78637*
= $350,000
12/31/17 Interest Expense
= ($350,000 – $51,574) × 5% = $14,921
Amortization Expense = $350,000 ÷ 8
= $43,750
*Present value of an annuity due of 1 for 8 periods at 5%.
Brief Exercise 21A-7
Larkspur Corporation recorded a right-of-use asset for $422,000 as a result of a finance lease on
December 31, 2016. Larkspur’s incremental borrowing rate is 14%, and the implicit rate of the
lessor was not known at the commencement of the lease. Larkspur made the first lease payment of
$70,968 on on December 31, 2016. The lease requires 10 annual payments. The equipment has a
useful life of 10 years with no residual value.
Prepare Larkspur's December 31, 2017, entries. (Credit account titles are automatically indented
when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 5,275.)
Date
December 31,
2017
Account Titles and Explanation
Debit
Lease Liability
Credit
21,824
Interest Expense
49,144
Cash
70,968
(To record interest expense)
December 31,
2017
Amortization Exp
42,200
Right-of-Use Ass
42,200
(To record amortization of the right-of-use
asset)
~
Interest Expense
= ($422,000 – $70,968) × 14% = $49,144
Amortization Expense = $422,000 ÷ 10
= $42,200
Brief Exercise 21A-10
Assume that IBM leased equipment that was carried at a cost of $174,000 to Sandhill Company.
The term of the lease is 5 years December 31, 2016, with equal rental payments of $46,499
beginning December 31, 2016. The fair value of the equipment at commencement of the lease is
$204,000. The equipment has a useful life of 5 years with no salvage value. The lease has an
implicit interest rate of 7%, no bargain purchase option, and no transfer of title. Collectibility of
lease payments for IBM is probable.
Prepare IBM’s December 31, 2016, journal entries at commencement of the lease. (Credit
account titles are automatically indented when amount is entered. Do not indent manually. For
calculation purposes, use 5 decimal places as displayed in the factor table provided and round final
answers to 0 decimal places e.g. 5,275.)
Date
December 31,
2016
Account Titles and Explanation
Debit
Credit
enter an account title To record the
lease
enter a debit
amount
enter a credit
amount
Lease Receivable
enter an account title To record the
lease
Cost of Goods S
enter an account title To record the
lease
204,000
enter a debit
amount
174,000
enter a debit
amount
Inventory
enter an account title To record the
lease
enter a credit
amount
enter a credit
amount
174,000
enter a debit
amount
Sales Revenue
enter a credit
amount
204,000
(To record the lease)
December 31,
2016
enter an account title To record receipt
of lease payment
Cash
enter an account title To record receipt
of lease payment
Lease Receivable
(To record receipt of lease payment)
~Lease Receivable = (4.38721* × $46,499) = $204,000
*Present value of an annuity due of 1 for 5 periods at 7%.
enter a debit
amount
enter a credit
amount
46,499
enter a debit
amount
enter a credit
amount
46,499
Brief Exercise 21A-11
Assume that IBM leased equipment that was carried at a cost of $183,000 to Cullumber Company.
The term of the lease is 6 years December 31, 2016, with equal rental payments of $41,763
beginning December 31, 2016. The fair value of the equipment at commencement of the lease is
$213,000. The equipment has a useful life of 6 years with no salvage value. The lease has an
implicit interest rate of 7%, no bargain purchase option, and no transfer of title. Collectibility of
lease payments for IBM is probable. Assume the sales-type lease was recorded at a present value
of $213,000.
Prepare IBM’s December 31, 2017, entry to record the lease transaction with Cullumber
Company. (Credit account titles are automatically indented when amount is entered. Do not
indent manually. Round answers to 0 decimal places e.g. 5,275.)
Account Titles and Explanation
Cash
Debit
Credit
41,763
Lease Receivable
29,776
Interest Revenue
11,987
~Lease Revenue = [($213,000 – $41,763) × 7%] = $11,987
Brief Exercise 21A-12
Kingbird Corporation manufactures drones. On December 31, 2016, it leased to Althaus
Company a drone that had cost $102,700 to manufacture. The lease agreement covers the 5-year
useful life of the drone and requires 5 equal annual rentals of $41,400 payable each December
31, beginning December 31, 2016. An interest rate of 10% is implicit in the lease agreement.
Collectibility of the rentals is probable.
Prepare Kingbird’s December 31, 2016, journal entries. (Credit account titles are automatically
indented when amount is entered. Do not indent manually. For calculation purposes, use 5
decimal places as displayed in the factor table provided and round final answers to 0 decimal
places e.g. 5,275.)
Date
December 31,
2016
Account Titles and Explanation
Debit
enter an account title To record the lease
enter a debit
amount
Lease Receiva
172,633
Credit
enter a credit
amount
enter an account title To record the lease
Cost of Goods
enter a debit
amount
enter a credit
amount
102,700
enter an account title To record the lease
enter a debit
amount
Inventory
enter a credit
amount
102,700
enter an account title To record the lease
enter a debit
amount
Sales Revenu
enter a credit
amount
172,633
(To record the lease)
December 31,
2016
enter an account title To record receipt of
lease payment
Cash
enter a debit
amount
enter a credit
amount
41,400
enter an account title To record receipt of
lease payment
Lease Receiva
enter a debit
amount
enter a credit
amount
41,400
(To record receipt of lease payment)
~Lease Receivable = ($41,400 × 4.16987*) = $172,633
*Present value of an annuity due 1 for 5 periods at 10%.
Brief Exercise 21A-13
Flint Corporation manufactures drones. On December 31, 2016, it leased to Althaus Company a drone
that had cost $258,000 to manufacture. The lease agreement covers the 5-year useful life of the
drone and requires five equal annual rentals of $86,800 payable each December 31, beginning
December 31, 2016. An interest rate of 6% is implicit in the lease agreement. Collectibility of the
rentals is not probable.
Prepare any journal entry for Flint on December 31, 2016. (Credit account titles are automatically
indented when the amount is entered. Do not indent manually.)
Account Titles and Explanation
Cash
Deposit Liabilit
Debit
Credit
86,800
86,800
~When collectibility of lease payments is not probable, the lessor does not derecognize the asset or
recognize selling profit on the lease. Instead, Flint would recognize any cash receipts as a deposit
liability.
Brief Exercise 21A-14
Carla Vista Company specializes in leasing large storage units to other businesses. Carla Vista
entered a contract to lease a storage unit to Riskey, Inc. for 4 years when that particular storage
unit had a remaining useful life of 5 years. The fair value of the unit was $19,000 at the
commencement of the lease on January 1, 2017. The present value of the five equal rental
payments of $5,180 at the start of each year, plus the present value of a guaranteed residual value
of $1,000, equals the fair value of $19,000, Carla Vista’s implicit rate of return on the lease of
9%. The following is a correct, complete amortization schedule created by Carla Vista.
Date
Lease Payment
Interest
(9%) on
Outstanding
Lease
Receivable
Reduction of
Lease
Receivable
1/1/17
Balance of
Lease
Receivable
$19,000
1/1/17
$5,180
$5,180
13,820
1/1/18
5,180
$1,244
3,936
9,884
1/1/19
5,180
890
4,290
5,594
1/1/20
5,180
503
4,677
917
12/31/20
1,000
83
917
0
$21,720
$2,720
$19,000
Given the above schedule, make the appropriate entries at December 31, 2020, to record the
accrual of interest and the return of the storage unit to Carla Vista (assuming the unit is returned
on December 31, 2020, at the expected and guaranteed residual value of $1,000). (Credit
account titles are automatically indented when the amount is entered. Do not indent
manually.)
Account Titles and Explanation
Lease Receiva
Interest Reven
(To record accrual of interest)
Debit
Credit
83
83
Inventory
1,000
Lease Receiva
1,000
(To record residual value of asset)
~
Brief Exercise 21A-15
LeBron James (LBJ) Corporation agrees on January 1, 2017, to lease equipment from Cavaliers, Inc.
for 3 years. The lease calls for annual lease payments of $18,000 at the beginning of each year. The
lease does not transfer ownership, nor does it contain a bargain purchase option, and is not a
specialized asset. In addition, the useful life of the equipment is 10 years, and the present value of the
lease payments is less than 90% of the fair value of the equipment.
Prepare LBJ’s journal entries on January 1, 2017 (commencement of the operating lease), and on
December 31, 2017. Assume the implicit rate used by the lessor is unknown, and LBJ’s incremental
borrowing rate is 6%. (Credit account titles are automatically indented when the amount is
entered. Do not indent manually. For calculation purposes, use 5 decimal places as
displayed in the factor table provided and round final answers to 0 decimal places, e.g.
5,275.)
Date
1/1/17
Account Titles and Explanation
Right-of-Use A
Debit
Credit
51,001
Lease Liability
51,001
(To record lease liability)
1/1/17
Lease Liability
18,000
Cash
18,000
(To record lease payment)
12/31/17
Lease Expens
18,000
Lease Liability
1,980
Right-of-Use A
16,020
~1/1/17: Right-of-Use Asset (2.83339* × $18,000) = $51,001
*Present value of an annuity due of 1 for 3 periods at 6%.
Schedule A
LEBRON JAMES CORPORATION
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual
Payment
Interest (6%) on
Liability
Reduction of
Lease Liability
Lease Liability
1/1/17
$51,001
1/1/17
$18,000
1/1/18
18,000
1/1/19
18,000
$0
$18,000
33,001
1,980 **
16,020
16,981
1,019
16,981
0
Schedule B
Lease Expense Schedule
(A)
Lease Expense
(Straight-Line)
Date
(B)
Interest (6%) on
Lease Liability
(c)
Amortization of
ROU Asset
(A - B)
1/1/17
Carrying Value of
ROU Asset
$51,001
12/31/17
$18,000
$1,980
$16,020
34,981
12/31/18
18,000
1,019
16,981
18,000
12/31/19
18,000
0
18,000
0
**The accrual of the lease liability is a result of the accrual of interest related to the lease liability, as
shown in schedule A. Note that this is expensed along with the amortization of the right-of-use asset
at the end of 2017
Brief Exercise 21A-16
Concord Corporation leases equipment from Falls Company on January 1, 2017. The lease agreement
does not transfer ownership, contain a bargain purchase option, and is not a specialized asset. It
covers 3 years of the equipment’s 8-year useful life, and the present value of the lease payments is
less than 90% of the fair value of the asset leased.
Prepare Concord’s journal entries on January 1, 2017, and December 31, 2017. Assume the annual
lease payment is $48,000 at the beginning of each year, and Concord’s incremental borrowing rate is
7%, which is the same as the lessor’s implicit rate. (Credit account titles are automatically
indented when the amount is entered. Do not indent manually. For calculation purposes,
use 5 decimal places as displayed in the factor table provided and round final answers to 0
decimal places, e.g. 5,265.)
Date
1/1/17
Account Titles and Explanation
Right-of-Use A
Debit
134,785
Credit
Lease Liability
134,785
(To record lease liability)
1/1/17
Lease Liability
48,000
Cash
48,000
(To record lease payment)
12/31/17
Lease Expens
48,000
Lease Liability
6,075
Right-of-Use A
41,925
~1/1/17: Right-of-Use Asset (2.80802* × $48,000) = $134,785
*Present value of an annuity due of 1 for 3 periods at 7%.
Schedule A
CONCORD CORPORATION
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual
Payment
Interest (7%) on
Liability
Reduction of
Lease Liability
1/1/17
Lease
Liability
$134,785
1/1/17
$48,000
1/1/18
48,000
1/1/19
48,000
$0
$48,000
86,785
6,075 **
41,925
44,860
3,140
44,860
0
Schedule B
Lease Expense Schedule
Date
(A)
Lease Expense
(Straight-Line)
(B)
Interest (7%) on
Lease Liability
(c)
Amortization of
ROU Asset
(A - B)
1/1/17
Carrying Value of
ROU Asset
$134,785
12/31/17
$48,000
$6,075
$41,925
92,860
12/31/18
48,000
3,140
44,860
48,000
12/31/19
48,000
0
48,000
0
**The accrual of the lease liability is a result of the accrual of interest related to the lease liability, as
shown in schedule A. Note that this is expensed along with the amortization of the right-of-use asset
at the end of 2017.
Brief Exercise 21A-17
Blue Corporation leases equipment from Falls Company on January 1, 2017. The lease
agreement does not transfer ownership, contain a bargain purchase option, and is not a
specialized asset. It covers 3 years of the equipment’s 8-year useful life, and the present value of
the lease payments is less than 90% of the fair value of the asset leased. The annual lease
payment is $30,000 at the beginning of each year, and Kingston’s incremental borrowing rate is
5%, which is the same as the lessor’s implicit rate.
Prepare all the necessary journal entries for Falls Company (the lessor) for 2017, assuming the
equipment is carried at a cost of $184,000. (Credit account titles are automatically indented
when the amount is entered. Do not indent manually.)
Date
1/1/17
Account Titles and Explanation
Cash
Debit
30,000
Unearned Lea
12/31/17
Unearned Lea
Credit
30,000
30,000
Lease Revenu
30,000
(To record the recognition of the revenue each period)
12/31/17
Depreciation E
23,000
Accumulated D
23,000
(To record depreciation expense on the leased equipment)
~Accumulated Depreciation – Leased Equipment = $184,000 ÷ 8 = $23,000
Brief Exercise 21A-18
Flounder Corporation agrees on January 1, 2017, to lease equipment from Packers, Inc. for 3 years.
The lease calls for annual lease payments of $10,500 at the beginning of each year. The lease does
not transfer ownership, contain a bargain purchase option, and is not a specialized asset. In addition,
the economic life of the equipment is 10 years, and the present value of the lease payments is less
than 90% of the fair value of the equipment.
Prepare Flounder’ journal entries on January 1, 2017 (commencement of the operating lease), and on
December 31, 2017. Assume the implicit rate used by the lessor is 5%, and this is known to
Flounder. (Credit account titles are automatically indented when the amount is entered. Do
not indent manually. For calculation purposes, use 5 decimal places as displayed in the
factor table provided and round final answers to "0" decimal places, e.g. 5,275.)
Date
1/1/17
Account Titles and Explanation
Right-of-Use A
Debit
Credit
30,024
Lease Liability
30,024
(To record lease liability)
1/1/17
Lease Liability
10,500
Cash
10,500
(To record lease payment)
12/31/17
Lease Expens
10,500
Lease Liability
976
Right-of-Use A
9,524
~1/1/17: Right-of-Use Asset (2.85941* × $10,500) = $30,024
*Present value of an annuity due of 1 for 3 periods at 5%.
Schedule A
FLOUNDER CORPORATION
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual
Payment
Interest (5%) on
Liability
Reduction of
Lease Liability
1/1/17
Lease Liability
$30,024
1/1/17
$10,500
$0
1/1/18
10,500
976 **
1/1/19
10,500
500
$10,500
19,524
9,524
10,000
10,000
0
Schedule B
Lease Expense Schedule
(A)
Straight-Line
Expense
Date
(B)
Interest on
Lease Liability
(c)
Amortization of
Right-of-Use Asset
(and Liability)
(A - B)
Carrying Value of
Right-of-Use Asset
1/1/17
$30,024
12/31/17
$10,500
$976
$9,524
20,500
12/31/18
10,500
500
10,000
10,500
12/31/19
10,500
0
10,500
0
**The accrual of the lease liability is a result of the accrual of interest related to the lease liability, as
shown in schedule A. Note that this is expensed along with the amortization of the right-of-use asset
at the end of 2017.
Brief Exercise 21A-23
Kingbird Corporation enters into a 6-year lease of equipment on December 31, 2016, which requires 6
annual payments of $37,400 each, beginning December 31, 2016. In addition, Kingbird guarantees
the lessor a residual value of $22,000 at the end of the lease. However, Kingbird believes it is
probable that the expected residual value at the end of the lease term will be $12,000. The equipment
has a useful life of 6 years. Assume that for Lost Ark Company, the lessor, collectibility of lease
payments is probable and the carrying amount of the equipment is $160,000.
Prepare Lost Ark’s 2016 and 2017 journal entries, assuming the implicit rate of the lease is 11% and
this is known to Kingbird. (Credit account titles are automatically indented when amount is
entered. Do not indent manually. For calculation purposes, use 5 decimal places as
displayed in the factor table provided and round final answers to 0 decimal places e.g.
5,275.)
Date
December 31, 2016
Account Titles and Explanation
Debit
Lease Receiva
187,389
Cost of Goods
160,000
Credit
Inventory
160,000
Sales Revenu
187,389
(To record the lease)
December 31, 2016
Cash
Lease Receiva
(To record receipt of lease payment)
37,400
37,400
December 31, 2017
Cash
37,400
Lease Receiva
20,901
Interest Reven
16,499
~
Lease Receivable = [($37,400 × 4.69590) + ($22,000 × 0.53464)] = $187,389
Interest Revenue = [($187,389 – $37,400) × 11%]
=
$16,499
Brief Exercise 21A-24
Skysong, Inc. has entered an agreement to lease an old warehouse with a useful life of 5 years and a
fair value of $30,000 from United Corporation. The agreement stipulates the following.
●
Rental payments of $6,838 are to be made at the start of each year of the 5-year lease. No
residual value is expected at the end of the lease.
●
Skysong must reimburse United each year for any real estate taxes incurred for the year. Last
year, the cost of real estate taxes was $700, though these costs vary from year to year.
●
Skysong must make a payment of $500 with the rental payment each period to cover the
insurance United has on the warehouse.
●
Skysong paid legal fees of $3,000 in executing the lease.
Assuming Skysong’s incremental borrowing rate is 7% and the rate implicit in the lease is unknown,
prepare the journal entry to record the initial lease liability and right-of-use asset for
Skysong. (Credit account titles are automatically indented when the amount is entered. Do
not indent manually. For calculation purposes, use 5 decimal places as displayed in the
factor table provided and round final answers to 0 decimal places, e.g. 5,275.)
Account Titles and Explanation
Right-of-Use A
Debit
Credit
35,194
Cash
3,000
Lease Liability
32,194
~Lease Liability
In calculating the lease liability, Skysong must determine which of the executory costs are considered
a component of the lease (to be considered in the measurement of the lease liability).
●
The real estate taxes in this case are variable payments and therefore are not considered in the
measurement of the lease liability and related right-of-use asset.
●
The fixed $500 insurance payments are included in the measurement of the lease liability because
the insurance costs are part of the rental payments. The lease liability is computed as follows:
PV of rental payments (4.38721* × $6,838):
$30,000
PV of insurance payments (4.38721* × $500):
Initial lease liability:
2,194
$32,194
*Present value of an annuity due of 1 for 5 periods at 7%
Right-of-Use Asset
The right-of-use asset is initially measured the same as the lease liability, though it is also adjusted
for any initial direct costs, prepaid rent, and lease incentives associated with the lease. The legal fees
resulting from the execution of the lease are considered initial direct costs, and must be included in
the calculation of the right-of-use asset:
Lease liability:
$32,194
Legal Fees:
Right-of-use asset:
3,000
$35,194
Brief Exercise 21A-26
Blue Corporation entered into an operating lease to lease equipment from Highlander, Inc. on January
1, 2017. The lease calls for annual lease payments of $11,000, beginning on December 31, for each of
the 5 years of the lease. In addition, Highlander, Inc. will pay Blue Corporation $3,400 as a cash
incentive for entering the lease by December 31. In relation to the lease agreement, Blue incurred the
following costs.
Commissions for selling agents
$600
Internal engineering costs
500
Legal fees resulting from the execution of the lease
3,800
Blue’s incremental borrowing rate is 7%. If the value of the lease liability is $48,259, what amount will
Blue record as the value of the right-of-use asset on January 1, 2017, at commencement of the
operating lease?
Value of the right-of-use asset
$
49,259
~
PV of lease payments:
Cash incentive received from Highlander (lessor):
Commissions for selling agents:
Legal fees resulting from the execution of the lease:
Measurement of right-of-use asset at 1/1/17:
$48,259
(3,400)
600
3,800
$49,259
Internal engineering costs are specifically excluded as initial direct costs, and would not be included in
the calculation of the right-of-use asset.
Note: The lease liability would not include any adjustments for cash incentive received, or any
included initial direct costs. The lease liability would only reflect the present value of future lease
payments.
Brief Exercise 21A-28
Blossom Corporation owns equipment that cost $81,600 and has a useful life of 8 years with no
salvage value. On January 1, 2017, Blossom leases the equipment to Havaci Inc. for one year with
one rental payment of $16,400 on January 1.
Assuming Havaci (lessee) elects to use the short-term lease exception, prepare Havaci's 2017 journal
entry. (Credit account titles are automatically indented when amount is entered. Do not
indent manually.)
Account Titles and Explanation
Lease Expens
Debit
Credit
16,400
Cash
16,400
~Because the lease term is only 1 year, the lessee treats the lease as a short term lease, does not
capitalize the asset on its books, and records lease payments as expenses when paid.
Brief Exercise 21A-29
On January 1, 2017, Flint Animation sold a truck to Peete Finance for $49,000 and immediately leased
it back. The truck was carried on Flint’s books at $42,000. The term of the lease is 3 years, there is no
bargain purchase option, and title does not transfer to Flint at lease-end. The lease requires three
equal rental payments of $15,000 at the end of each year (first payment on January 1, 2018). The
appropriate rate of interest is 6%, the truck has a useful life of 5 years, and the residual value at the
end of the lease term is expected to be $14,000, none of which is guaranteed.
Prepare Flint’s 2017 journal entries. (Credit account titles are automatically indented when the
amount is entered. Do not indent manually. For calculation purposes, use 5 decimal places
as displayed in the factor table provided and round final answers to 0 decimal places, e.g.
5,265.)
Date
1/1/17
Account Titles and Explanation
Cash
Debit
Credit
49,000
Gain on Dispo
7,000
Trucks
42,000
(To record sale of truck)
1/1/17
Right-of-Use A
40,095
Lease Liability
40,095
(To record lease liability)
12/31/17
Lease Expens
15,000
Lease Liability
2,406
Right-of-Use A
12,594
~The transaction between Flint and Peete will qualify as a sale-leaseback, as Flint has transferred
control of the asset to Peete. That is, the terms of the leaseback do not meet any of the tests to be
classified as a finance lease, and thus does not transfer control back to Flint. Flint will recognize a gain
on the sale of the asset, and record a right-of-use asset and corresponding lease liability for the
operating lease entered into with Peete. Subsequent accounting treatment will follow the normal
accounting for an operating lease.
1/1/17: Lease Liability ($15,000 × 2.67301*) = $40,095
*Present value of an ordinary annuity for 3 periods at 6%.
FLINT ANIMATION
Lease Amortization Schedule
Ordinary-Annuity Basis
Date
Annual
Payment
Interest (6%) on
Liability
Reduction of
Lease Liability
1/1/17
Lease Liability
$40,095
1/1/18
$15,000
$2,406
$12,594
27,501
1/1/19
15,000
1,650
13,350
14,151
1/1/20
15,000
14,151
0
849 *
*Rounded $1
Lease Expense Schedule
Date
(A)
Lease Expense
(Straight-Line)
(B)
Interest (6%) on
Liability
(C)
Amortization of
ROU Asset
(A - B)
1/1/17
Carrying Value of
ROU Asset
$40,095
12/31/17
$15,000
$2,406
$12,594
27,501
12/31/18
15,000
1,650
13,350
14,151
12/31/19
15,000
849
14,151
0
Brief Exercise 21A-30
On January 1, 2017, Grouper Animation sold a truck to Peete Finance for $44,000 and immediately
leased it back. The truck was carried on Grouper’s books at $40,000. The term of the lease is 5 years,
there is no bargain purchase option, and title does not transfer to Grouper at lease-end. The lease
requires 5 equal rental payments of $9,884 at the end of each year (first payment on January 1,
2018). The appropriate rate of interest is 4%, the truck has a useful life of 5 years, with no expected
residual value at the end of the lease term.
Prepare Grouper’s 2017 journal entries assuming these new facts. (Credit account titles are
automatically indented when the amount is entered. Do not indent manually. For calculation
purposes, use 5 decimal places as displayed in the factor table provided and round final
answers to 0 decimal places, e.g. 5,275.)
Date
1/1/17
Account Titles and Explanation
Debit
enter an account title for the journal entry on
January 1 2017
enter a debit
amount
Cash
enter an account title for the journal entry on
January 1 2017
12/31/17
Interest Expen
enter an account title for the journal entry on
December 31 2017
Interest Payab
enter a credit
amount
44,002
enter a debit
amount
Notes Payable
enter an account title for the journal entry on
December 31 2017
Credit
enter a credit
amount
44,002
enter a debit
amount
enter a credit
amount
1,760
enter a debit
amount
enter a credit
amount
1,760
~With the change of facts, the leaseback meets the lease term and present value classification tests
(5/5 = 100% of asset’s economic life; $9,884 × 4.45182 = $44,002 = 100% of asset’s fair value). As
a result, the lease is a finance lease for Grouper. Consequently, Grouper has control of the asset from
the lease arrangement, and has never given up control of the asset (i.e., a failed sale). Therefore,
Grouper will not recognize any gain on the sale of the asset, but instead record a note payable to
demonstrate the financing-nature of the transaction.
1/1/17: Notes Payable = $9,884 × 4.45182* = $44,002
* Present value of an ordinary annuity for 5 periods at 4%.
12/31/17: Interest Payable = $44,002 × 4% = $1,760
This sale-leaseback arrangement is a financing transaction and is often referred to as a failed sale.
Exercise 21A-23
Assume that on January 1, 2017, Elmer’s Restaurants sells a computer system to Crane Finance Co.
for $640,000 and immediately leases the computer system back. The relevant information is as
follows.
1.
The computer was carried on Elmer’s books at a value of $560,000.
2.
The term of the non-cancelable lease is 3 years; title will not transfer to Elmer’s, and the
expected residual value at the end of the lease is $410,000, all of which is unguaranteed.
3.
The lease agreement requires equal rental payments of $117,590 at the beginning of each year.
4.
The incremental borrowing rate for Elmer is 5%. Elmer is aware that Crane Finance Co. set the
annual rental to insure a rate of return of 5%.
5.
The computer has a fair value of $640,000 on January 1, 2017, and an estimated economic life of
10 years.
Prepare the journal entries for both the lessee and the lessor for 2017 to reflect the sale and
leaseback agreement. (For calculation purposes, use 5 decimal places as displayed in the
factor table provided and round answers to 0 decimal places, e.g. 5,275. Credit account
titles are automatically indented when amount is entered. Do not indent manually.)
Date
Account Titles and Explanation
Debit
Credit
Elmer’s Restaurants (Lessee)
1/1/17
Cash
640,000
Gain on Sale of Equipment
80,000
Equipment
560,000
(To record sale of equipment)
Right-of-Use Asset
336,238
Lease Liability
336,238
(To record the lease)
Lease Liability
117,590
Cash
117,590
(To record lease liability)
12/31/17
Lease Expense
117,590
Right-of-Use Asset
106,658
Lease Liability
10,932
Crane Finance Co. (Lessor)
1/1/17
Equipment
640,000
Cash
640,000
(To record purchase of equipment)
Cash
117,590
Unearned Lease Revenue
117,590
(To record the leaseback)
Unearned Lease Revenue
117,590
Lease Revenue
117,590
(To record the recognition of the revenue)
Depreciation Expense
64,000
Accumulated Depreciation-Equipment
64,000
(To record depreciation expense on the leased
equipment)
~Elmer’s Restaurants (Seller-Lessee): Lease should be treated as an operating lease because none of
the finance lease classification tests are met.
1/1/17: Right-of-Use Asset = $117,590 × 2.85941* = $336,238
*Present value of an annuity due for 3 periods at 5%.
ELMER’S RESTAURANTS
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual Interest (5%)
Payment
on Liability
Reduction of
Lease Liability Lease Liability
1/1/17
$336,238
1/1/17 $117,590
1/1/18
117,590
1/1/19
117,590
$0
$117,590
218,648
10,932
106,658
111,990
111,990
0
5,600*
*Difference due to rounding.
Lease Expense Schedule
Date
(A)
Lease Expense
(Straight-Line)
(B)
Interest (5%) on
Lease Liability
(C)
Amortization of
ROU Asset
(A-B)
1/1/17
Carrying Value
of ROU
Asset
$336,238
12/31/17
$117,590
$10,932
$106,658
229,580
12/31/18
117,590
5,600
111,990
117,590
12/31/19
117,590
0
117,590
0
Crane Finance Co. (Buyer-Lessor): Lease should be treated as an operating lease because the lease
does not meet any of the sales-type classification tests.
Accumulated Depreciation – Equipment = $640,000 ÷ 10 = $64,000
Exercise 21A-24 a-c
Respond to the requirements in each situation.
(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
On January 1, 2017, Flint Inc. sold computer equipment to Tamarisk Co. The sales price of the
equipment was $516,000 and its carrying amount is $407,000. Record any journal entries necessary
for Flint from the sale of the computer equipment in 2017. (Credit account titles are automatically
indented when the amount is entered. Do not indent manually. Round answer to 0 decimal
places, e.g. 5,275.)
Date Account Titles and Explanation
1/1/17
Cash
Debit
Credit
516,000
Gain on Dispo
109,000
Equipment
407,000
~The situation described is a simple sale of equipment.
Use the information from part (a). Assume that, on the same day the sale occurred, Flint enters into
an agreement to lease the equipment from Tamarisk for 10 years with annual lease payments of
$73,467 at the end of each year, beginning on December 31, 2017. If Flint has an incremental
borrowing rate of 7% and the equipment has an economic useful life of 10 years, record any journal
entries necessary for Flint from the sale and leaseback of computer equipment in 2017. (Credit
account titles are automatically indented when the amount is entered. Do not indent
manually. Round answers to 0 decimal places, e.g. 5,275.)
Date
1/1/17
Account Titles and Explanation
Cash
Debit
516,000
Notes Payable
12/31/17
Credit
516,000
Interest Expen
36,120
Notes Payable
37,347
Cash
73,467
~The situation described is known as a failed sale. That is, the terms of the lease meet the criteria to
be classified as a finance lease to the lessee (lease term > 75% of economic life, present value of
lease payments > 90% of fair value of the asset). Under a finance lease, the lessee is deemed to have
taken control of the asset. However, since the sale and the lease occur on the same day, the
seller/lessee is deemed to never have given up control in the first place, and the lease is viewed
simply as a financing arrangement. The present value of the lease payments is $516,000 [$73,467 ×
7.02358*], which is 100% of the fair value of the asset.
*Present value of an ordinary annuity for 10 years at 7%.
Interest Expense = $516,000 × 7% = $36,120
Use the information from part (b). Now, instead of 10 years, the lease term is only 3 years with
annual lease payments of $73,467 at the beginning of each year. Record any journal entries necessary
for Flint from the sale and leaseback of computer equipment in 2017. (Credit account titles are
automatically indented when the amount is entered. Do not indent manually. Round
answers to 0 decimal places, e.g. 5,275.)
Date
1/1/17
Account Titles and Explanation
Cash
Debit
Credit
516,000
Gain on Dispo
109,000
Equipment
407,000
(To record sale of equipment)
Right-of-Use A
206,297
Lease Liability
206,297
(To record the lease)
Lease Liability
73,467
Cash
73,467
(To record lease liability)
12/31/17
Lease Expens
73,467
Right-of-Use A
64,169
Lease Liability
9,298
~The situation described is considered a sale-leaseback agreement for financial reporting purposes.
That is, the terms of the lease meet the criteria to be classified as an operating lease to the lessee
(lease term < 75% of economic life, present value of lease payments < 90% of fair value of the
asset). Under an operating lease, the lessee is not deemed to take control of the asset. However,
upon the sale of the asset, the seller-lessee does relinquish control of the asset, and thus can
recognize any gain on the sale. The lease is accounted for as a normal operating lease.
1/1/17: Right-of-Use Asset = ($73,467 × 2.80802*) = $206,297
*Present value of an annuity due for 3 periods at 7%.
FLINT INC.
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual Payment
Interest (7%) Reduction of
on Liability
Lease Liability Lease Liability
1/1/17
$206,297
1/1/17
$73,467
$0
$73,467
132,830
1/1/18
73,467
9,298
64,169
68,661
1/1/19
73,467
4,806
68,661
0
Lease Expense Schedule
Date
(A)
Lease Expense
(Straight-Line)
(B)
Interest (7%) on
Lease Liability
(C)
Amortization of
ROU Asset
(A-B)
1/1/17
Carrying Value
of ROU
Asset
$206,297
12/31/17
$73,467
$9,298
$64,169
142,128
12/31/18
73,467
4,806
68,661
73,467
12/31/19
73,467
0
73,467
0