Chapter 21 Flashcards by Reeda-Marie Chavez

On December 1, 2008, Perez Corporation leased office space for 10 years at a monthly rental of $90,000. On that date Perez paid the landlord the following amounts:
Rent deposit $ 90,000
First month’s rent 90,000
Last month’s rent 90,000
Installation of new walls and offices 495,000
= $765,000
The entire amount of $765,000 was charged to rent expense in 2008. What amount should Perez have charged to expense for the year ended December 31, 2008?

90,000 + ((495,000/10) * (1/2)) = 94,125

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On January 1, 2008, Penn Corporation signed a ten-year noncancelable lease for certain machinery. The terms of the lease called for Penn to make annual payments of $100,000 at the end of each year for ten years with title to pass to Penn at the end of this period. The machinery has an estimated useful life of 15 years and no salvage value. Penn uses the straight-line method of depreciation for all of its fixed assets. Penn accordingly accounted for this lease transaction as a capital lease. The lease payments were determined to have a present value of $671,008 at an effective interest rate of 8%. With respect to this capitalized lease, Penn should record (interest expense and depreciation expense) for 2008

671,008 × .08 = $53,681 Interest Expense
$671,008 ÷ 15 = $44,734 depreciation expense

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On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter depreciates similar buildings on the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Dexter’s incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Dexter, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.

What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.)

3,000,000 ÷ (PVF-OA10%,10) = $488,236

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What is the amount of the total annual lease payment?

488,236 + $10,000 = $498,237

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From the lessor’s viewpoint, what type of lease is involved?

Sales Type Lease, FV exceeds cost

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From the lessee’s viewpoint, what type of lease exists in this case?

Capital Lease

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Dexter, Inc. would record depreciation expense on this storage building in 2008 of (Rounded to the nearest dollar.)

$3,000,000 ÷ 10 = $300,000

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If the lease were nonrenewable, there was no purchase option, title to the building does not pass to the lessee at termination of the lease and the lease were only for eight years, what type of lease would this be for the lessee?

8/10 = .8 > 75% of economic life
Capital Lease

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Huffman Company leases a machine from Lincoln Corp. under an agreement which meets the criteria to be a capital lease for Huffman. The six-year lease requires payment of $102,000 at the beginning of each year, including $15,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 10%; the lessor’s implicit rate is 8% and is known by the lessee. The present value of an annuity due of 1 for six years at 10% is 4.79079. The present value of an annuity due of 1 for six years at 8% is 4.99271. Huffman should record the leased asset at

($102,000 - $15,000) × 4.99271 = $434,366.

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On December 31, 2007, Pool Corporation leased a ship from Renn Company for an eight-year period expiring December 30, 2015. Equal annual payments of $200,000 are due on December 31 of each year, beginning with December 31, 2007. The lease is properly classified as a capital lease on Pool’s books. The present value at December 31, 2007 of the eight lease payments over the lease term discounted at 10% is $1,173,685. Assuming all payments are made on time, the amount that should be reported by Pool Corporation as the total obligation under capital leases on its December 31, 2008 balance sheet is

$1,173,685 – $200,000 = $973,685 × .10 = $97,369
973,685 – ($200,000 – $97,369) = $871,054

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On January 1, 2008, Dalton Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Dalton to make annual payments of $50,000 at the beginning of each year for five years with title to pass to Dalton at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Dalton uses the straight-line method of depreciation for all of its fixed assets. Dalton accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $208,493 at an effective interest rate of 10%

In 2008, Dalton should record interest expense of

($208,493 – $50,000) × .10 = $15,849

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In 2009, Dalton should record interest expense of

[$158,493 – ($50,000 - $15,849)] × .10 = $12,434

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On December 31, 2008, Dodd Corporation leased a plane from Aero Company for an eight-year period expiring December 30, 2016. Equal annual payments of $150,000 are due on December 31 of each year, beginning with December 31, 2008. The lease is properly classified as a capital lease on Dodd’s books. The present value at December 31, 2008 of the eight lease payments over the lease term discounted at 10% is $880,264. Assuming the first payment is made on time, the amount that should be reported by Dodd Corporation as the lease liability on its December 31, 2008 balance sheet is

$880,264 – $150,000 = $730,264

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On January 1, 2008, Carley Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Carley to make annual payments of $60,000 at the end of each year for five years with title to pass to Carley at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Carley uses the straight-line method of depreciation for all of its fixed assets. Carley accordingly accounts for this lease transaction as a capital lease. The minimum lease payments were determined to have a present value of $227,448 at an effective interest rate of 10%.

With respect to this capitalized lease, for 2008 Carley should record (interest expense and depreciation expense)

$227,448 × .10 = $22,745 interest Expense
($227,448 – 0) ÷ 7 = $32,493 Depreciation Expense

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With respect to this capitalized lease, for 2009 Carley should record (interest expense)

[$227,448 – ($60,000 – $22,745)] × .10 = $19,019 interest expense

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Barkley Corporation is a lessee with a capital lease. The asset is recorded at $450,000 and has an economic life of 8 years. The lease term is 5 years. The asset is expected to have a market value of $150,000 at the end of 5 years, and a market value of $50,000 at the end of 8 years. The lease agreement provides for the transfer of title of the asset to the lessee at the end of the lease term. What amount of depreciation expense would the lessee record for the first year of the lease?

($450,000 – $50,000) ÷ 8 = $50,000

Hay Corporation enters into an agreement with Marly Rentals Co. on January 1, 2008 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement:
(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $155,213 are due on December 31 of each year.
(b) The fair value of the machine on January 1, 2008, is $400,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease.
(c) Hay depreciates all machinery it owns on a straight-line basis.
(d) Hay’s incremental borrowing rate is 10% per year. Hay does not have knowledge of the 8% implicit rate used by Marly.
(e) Immediately after signing the lease, Marly finds out that Hay Corp. is the defendant in a suit which is sufficiently material to make collectibility of future lease payments doubtful.

What type of lease is this from Hay Corporation’s viewpoint?

155,213 × 2.48685 = $385,991
(385,991/400,000) = 96% > 90%
Capital Lease

If Hay accounts for the lease as an operating lease, what expenses will be recorded as a consequence of the lease during the fiscal year ended December 31, 2008?

Rent Expense

If the present value of the future lease payments is $400,000 at January 1, 2008, what is the amount of the reduction in the lease liability for Hay Corp. in the second full year of the lease if Hay Corp. accounts for the lease as a capital lease? (Rounded to the nearest dollar.)

$400,000 – [$155,213 – ($400,000 × .1)] = $284,787.
155,213 – ($284,787 ×.1) = $126,734

From the viewpoint of Marly, what type of lease agreement exists?

Operating Lease, Fails to meet Group II requirements

If Marly records this lease as a direct-financing lease, what amount would be recorded as Lease Receivable at the inception of the lease?

Fair value = $400,000

Which of the following lease-related revenue and expense items would be recorded by Marly if the lease is accounted for as an operating lease?

Rental Revenue and Depreciation Expense

Sele Company leased equipment to Snead Company on July 1, 2007, for a one-year period expiring June 30, 2008, for $60,000 a month. On July 1, 2008, Sele leased this piece of equipment to Quirk Company for a three-year period expiring June 30, 2011, for $75,000 a month. The original cost of the equipment was $4,800,000. The equipment, which has been continually on lease since July 1, 2003, is being depreciated on a straight-line basis over an eight-year period with no salvage value. Assuming that both the lease to Snead and the lease to Quirk are appropriately recorded as operating leases for accounting purposes, what is the amount of income (expense) before income taxes that each would record as a result of the above facts for the year ended December 31, 2008?

Sele: ($60,000 × 6) + ($75,000 × 6) – (4,800,000 ÷ 8) = $210,000
Snead: ($60,000) × 6 = $(360,000)
Quirk: ($75,000) × 6 = $(450,000)

Eddy leased equipment to Hoyle Company on May 1, 2008. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2009. Hoyle could have bought the equipment from Eddy for $3,200,000 instead of leasing it. Eddy’s accounting records showed a book value for the equipment on May 1, 2008, of $2,800,000. Eddy’s depreciation on the equipment in 2008 was $360,000. During 2008, Hoyle paid $720,000 in rentals to Eddy for the 8-month period. Eddy incurred maintenance and other related costs under the terms of the lease of $64,000 in 2008. After the lease with Hoyle expires, Eddy will lease the equipment to another company for two years.

Ignoring income taxes, the amount of expense incurred by Hoyle from this lease for the year ended December 31, 2008, should be

720,000

Eddy leased equipment to Hoyle Company on May 1, 2008. At that time the collectibility of the minimum lease payments was not reasonably predictable. The lease expires on May 1, 2009. Hoyle could have bought the equipment from Eddy for $3,200,000 instead of leasing it. Eddy's accounting records showed a book value for the equipment on May 1, 2008, of $2,800,000. Eddy's depreciation on the equipment in 2008 was $360,000. During 2008, Hoyle paid $720,000 in rentals to Eddy for the 8-month period. Eddy incurred maintenance and other related costs under the terms of the lease of $64,000 in 2008. After the lease with Hoyle expires, Eddy will lease the equipment to another company for two years. The income before income taxes derived by Eddy from this lease for the year ended December 31, 2008, should be

$720,000 – $64,000 – $360,000 = $296,000

Hite Company has a machine with a cost of $400,000 which also is its fair market value on the date the machine is leased to Rich Company. The lease is for 6 years and the machine is estimated to have an unguaranteed residual value of $40,000. If the lessor's interest rate implicit in the lease is 12%, the six beginning-of-the-year lease payments would be

[$400,000 – ($40,000 × .50663)] ÷ 4.60478 = $82,465

Estes Co. leased a machine to Dains Co. Assume the lease payments were made on the basis that the residual value was guaranteed and Estes gets to recognize all the profits, and at the end of the lease term, before the lessee transfers the asset to the lessor, the leased asset and obligation accounts have the following balances: Leased equipment under capital lease $400,000 Less accumulated depreciation--capital lease 384,000 =16,000 Interest payable $ 1,520 Obligations under capital leases 14,480 = $16,000 If, at the end of the lease, the fair market value of the residual value is $8,800, what gain or loss should Estes record?

$8,800 – $16,000 = ($7,200)

Durham Company leased machinery to Santi Company on July 1, 2008, for a ten-year period expiring June 30, 2018. Equal annual payments under the lease are $75,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest used by Durham and Santi is 9%. The cash selling price of the machinery is $525,000 and the cost of the machinery on Durham's accounting records was $465,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Durham, what amount of interest revenue would Durham record for the year ended December 31, 2008?

($525,000 – $75,000) × .09 × 6/12 = $20,250

Eby Company leased equipment to the Mills Company on July 1, 2008, for a ten-year period expiring June 30, 2018. Equal annual payments under the lease are $80,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest contemplated by Eby and Mills is 9%. The cash selling price of the equipment is $560,000 and the cost of the equipment on Eby's accounting records was $496,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Eby, what is the amount of profit on the sale and the interest revenue that Eby would record for the year ended December 31, 2008?

560,000 – $496,000 = $64,000 ($560,000 – $80,000) × .09 × 6/12 = $21,600

Risen Company, a dealer in machinery and equipment, leased equipment to Foran, Inc., on July 1, 2008. The lease is appropriately accounted for as a sale by Risen and as a purchase by Foran. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2018. The first of 10 equal annual payments of $621,000 was made on July 1, 2008. Risen had purchased the equipment for $3,900,000 on January 1, 2008, and established a list selling price of $5,400,000 on the equipment. Assume that the present value at July 1, 2008, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $4,500,000. Assuming that Foran, Inc. uses straight-line depreciation, what is the amount of deprecia-tion and interest expense that Foran should record for the year ended December 31, 2008?

(4,500,000/10) * (1/2) = 225,000 ($4,500,000 – $621,000) × .04 = $155,160

Risen Company, a dealer in machinery and equipment, leased equipment to Foran, Inc., on July 1, 2008. The lease is appropriately accounted for as a sale by Risen and as a purchase by Foran. The lease is for a 10-year period (the useful life of the asset) expiring June 30, 2018. The first of 10 equal annual payments of $621,000 was made on July 1, 2008. Risen had purchased the equipment for $3,900,000 on January 1, 2008, and established a list selling price of $5,400,000 on the equipment. Assume that the present value at July 1, 2008, of the rent payments over the lease term discounted at 8% (the appropriate interest rate) was $4,500,000. What is the amount of profit on the sale and the amount of interest income that Risen should record for the year ended December 31, 2008?

$4,500,000 – $3,900,000 = $600,000. ($4,500,000 – $621,000) × .04 = $155,160

Mayer Company leased equipment from Lennon Company on July 1, 2008, for an eight-year period expiring June 30, 2016. Equal annual payments under the lease are $300,000 and are due on July 1 of each year. The first payment was made on July 1, 2008. The rate of interest contemplated by Mayer and Lennon is 8%. The cash selling price of the equipment is $1,861,875 and the cost of the equipment on Lennon's accounting records was $1,650,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Lennon, what is the amount of profit on the sale and the interest income that Lennon would record for the year ended December 31, 2008?

$1,861,875 – $1,650,000 = $211,875. ($1,861,875 – $300,000) × .04 = $62,475

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On June 30, 2008, Colt sold equipment to an unaffiliated company for $700,000. The equipment had a book value of $630,000 and a remaining useful life of 10 years. That same day, Colt leased back the equipment at $7,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Colt's rent expense for this equipment for the year ended December 31, 2008, should be

7,000 × 6 = $42,000