ACCT 331 Lecture Notes - Lecture 10: Financial Statement, Finance Lease, Operating Lease
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# Warren Co. recorded a right-of-use asset of $800,000 in a10-year Type A lease. The interest rate charged by the lessor was8%. Under the new ASU, the balance in the right-of-use asset aftertwo years will be:
#Refer to the following lease amortization schedule. The 10payments are made annually starting with the inception of thelease. Title does not transfer to the lessee and there is nobargain purchase option or guaranteed residual value. The asset hasan expected economic life of 12 years. The lease isnoncancelable.
| Payment | Cash Payment | Effective Interest | Decrease in balance | Balance |
| 63,282 | ||||
| 1 | 10,000 | 10,000 | 53,282 | |
| 2 | 10,000 | 6,394 | 3,606 | 49,676 |
| 3 | 10,000 | 5,961 | 4,039 | 45,638 |
| 4 | 10,000 | 5,477 | 4,523 | 41,114 |
| 5 | 10,000 | 4,934 | 5,066 | 36,048 |
| 6 | 10,000 | 4,326 | 5,674 | 30,373 |
| 7 | 10,000 | 3,645 | 6,355 | 24,018 |
| 8 | 10,000 | 2,882 | 7,118 | 16,901 |
| 9 | 10,000 | ? | ? | ? |
| 10 | 10,000 | ? | ? | ? |
What would the lessee record as annual depreciation on the assetusing the straight-line method?
#XYZ Company leased equipment to West Corporation under a leaseagreement that qualifies as a capital lease to West but not as aresult of a bargain purchase option or a title transfer. Thepresent value of the asset is $600,000. The expected economic lifeof the asset is 10 years. The lease term is five years. Using thestraight-line method, what would West record as annualdepreciation?
# If the lessee and lessor use different interest rates toaccount for a capital lease, then:
Total expenses for the lessee will be different from thelessor's total revenues.
Total expenses for the lessee will equal the lessor's totalrevenues.
GAAP has been violated by at least one party.
The lessee will report more net income for the year.
##
Technoid Inc. sells computer systems. Technoid leases computersto Lone Star Company on January 1, 2016. The manufacturing cost ofthe computers was $12 million.
This noncancelable lease had the following terms:
⢠Lease payments: $2,466,754 semiannually; first payment at January1, 2016; remaining payments at June 30 and December 31 each yearthrough June 30, 2020.
⢠Lease term: five years (10 semiannual payments).
⢠No residual value; no bargain purchase option.
⢠Economic life of equipment: five years.
⢠Implicit interest rate and lessee's incremental borrowing rate:5% semiannually.
⢠Fair value of the computers at January 1, 2016: $20million.
Collectibility of the rental payments is reasonably assured, andthere are no lessor costs yet to be incurred.
Lone Star Company would account for this as:
A capital lease.
A direct financing lease.
A sales type lease.
An operating lease.
##
Refer to the following lease amortization schedule. The 10payments are made annually starting with the inception of thelease. Title does not transfer to the lessee and there is nobargain purchase option or guaranteed residual value. The asset hasan expected economic life of 12 years. The lease isnoncancelable.
| Payment | Cash Payment | Effective Interest | Decrease in balance | Balance |
| 63,282 | ||||
| 1 | 10,000 | 10,000 | 53,282 | |
| 2 | 10,000 | 6,394 | 3,606 | 49,676 |
| 3 | 10,000 | 5,961 | 4,039 | 45,638 |
| 4 | 10,000 | 5,477 | 4,523 | 41,114 |
| 5 | 10,000 | 4,934 | 5,066 | 36,048 |
| 6 | 10,000 | 4,326 | 5,674 | 30,373 |
| 7 | 10,000 | 3,645 | 6,355 | 24,018 |
| 8 | 10,000 | 2,882 | 7,118 | 16,901 |
| 9 | 10,000 | ? | ? | ? |
| 10 | 10,000 | ? | ? | ? |
What would be the outstanding balance after payment 10?
## Cady Salons leased equipment from Smith Co. on January 1,2016, in a Type B lease. The present value of the lease paymentsdiscounted at 10% was $80,000. Ten annual lease payments of $12,000are due at each January 1 beginning January 1, 2016. Following theguidance of the new ASU, the amortization of the right-of-use assetfor the reporting year ending December 31, 2016, would be:
## Karla Salons leased equipment from Smith Co. on July 1, 2016,in a Type A lease. The present value of the lease paymentsdiscounted at 10% was $80,000. Ten annual lease payments of $12,000are due each year beginning July 1, 2016. Smith Co. had constructedthe equipment recently for $66,000, and its retail fair value was$80,000.
Under the new ASU, what amount of interest revenue from the leaseshould Smith Co. report in its December 31, 2016, incomestatement?
### If the leaseback portion of a sale-leaseback transaction isclassified as an operating lease:
Any gain is deferred and recognized as a reduction of rentexpense.
Any gain is deferred and recognized as a reduction ofdepreciation.
Any gain is recognized at the lease's inception.
There can be no gain.
Kola Corporation (âKolaâ) leases quality weapons to customers. She gains a loyal following of customers because quality is of limited supply but high demand due to its usefulness for the upcoming winter. Further, Kola tends to offer more favorable financing terms than competitors offering substitutive products (e.g., Walnut, LLC).
Kola was recently approached by the Noodle, Inc. (Noodle) which is interested in leasing a substantial stock of weapons over a potentially lengthy period of time. Noodle has indicated a willingness to pay any rate that Kola Corporation demands for its quality products, but generally receives an interest rate of 12% on all other borrowing transactions. Noodleâs management are a very noble group, so payments are reasonably assured. Further, there are no material cost uncertainties.
Kola has gathered its council to discuss entering into such a contract with Noodle and has invited you to provide financial council. Kolaâs board has proposed several alternative sets of lease terms (below) and would like you determine what Noodleâs annual payments will be under each scenario, if payments are made at the beginning of the period.
| A | B | C | D | |
| Fair value of weapons to be leased | $365,760 | $365,760 | $365,760 | $365,760 |
| Book value of weapons to be leased | $365,760 | $290,760 | $365,760 | $365,760 |
| Desired Profit on Lease Initiation | $0 | $75,000 | $0 | $0 |
| Lease Term | 11 years | 11 years | 6 years | 6 years |
| Useful Life of leased assets | 13 years | 13 years | 6 years | 6 years |
| Desired rate of return | 10% | 10% | 10% | 13.225% |
| Residual Value (guaranteed) | $24,350 | $24,350 | $25,000 | $75,000 |
REQUIRED:
Prepare a schedule for Kola which uses Excel to compute Noodleâs necessary annual payment under each of the scenarios listed in the chart above. The schedule should list for each scenario above the desired present value of lease payments, future value of the leased asset, the lease term, and the interest rate and utilize an Excel formula to compute a payment. Kola is a high paying client of your firm, so the schedule should be extremely organized and professional looking (e,g., include a title, date, description in the top left-hand corner and utilize borders, font effects, etc. in cells to make the worksheet look visually appealing).
(Note: You must use only Excel to prepare and present all parts of this table. Do not use a hand-held calculator, and do not use the compound interest tables to solve any part of this problem. Points will be deducted if Excel formulas are not used for each necessary computation.)
Prepare a worksheet that determines the type of lease for each party to the transaction. The purpose of this worksheet is to automate the determination of lease type. This worksheet should show:
The particulars for each lease scenario.
List each capital lease requirement and indicate whether or not it is met
Use Excel formulas where meeting a particular criteria requires a calculation or is contingent on one of the lease criteria (e.g., âifâ statements). The only items that should be hard-keyed in here are the particulars for the lease scenario and the answers to the first two capital lease criteria (ownership transfer, and bargain purchase option) for the lessee/lessor and the answers to the two lessor-only capital lease criteria.
For the requirements below, assume Kola Corporation chooses lease option A and enters into an agreement with Noodle on 1/1/18. Noodle should return the weapons on 12/31/2028.
Prepare a lease amortization schedule describing the pattern of payments and interest over the lease term for both Kola and Noodle.
(Note: You must use only Excel to prepare and present all parts of this table. Do not use a hand-held calculator, and do not use the compound interest tables to solve any part of this problem.)
Prepare the appropriate entries for both Kola and Noodle on 1/1/18. Numbers in journal entries should be linked to the table prepared in number 3 above or computed using Excel formulas.
Prepare the appropriate entries for both Kola and Noodle through 1/1/21. Numbers in journal entries should be linked to the table prepared in number 3 above or computed using Excel formulas.
Prepare the appropriate entries for both Kola and Noodle on 12/31/2028. Assume the weapons returned to Kola have a residual value of $500.
On January 1, 2013, NRC Credit Corporation leased equipment toBrand Services under a direct financing lease designed to earn NRCa 12% rate of return for providing long-term financing. The leaseagreement specified:
| a. | Twelve annual payments of $64,000 (including executory costs)beginning January 1, 2013, the inception of the lease and eachDecember 31 thereafter through 2021. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| b. | The estimated useful life of the leased equipment is 12 yearswith no residual value. Its cost to NRC was $403,080. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| c. | The leasequalifies as a capital lease to Brand. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| d. | A 12-year service agreement with Quality Maintenance Company wasnegotiated to provide maintenance of the equipment as required.Payments of $5,900 per year are specified, beginning January 1,2013. NRC was to pay this executory cost as incurred, but leasepayments reflect this expenditure. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| A partial amortization schedule, appropriate for boththe lessee and lessor, follows
Assume the contract specified that NRC (the lessor) wasto pay, not only the $5,900 maintenance fees, but also insurance of$790 per year, and was to receive a $340 management fee forfacilitating service and paying executory costs. The lesseeâs leasepayments were increased to include an amount sufficient toreimburse executory costs plus NRCâs fee.
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