Was the junior accountant\'s analysis correct? Why or why not? Lessee Ltd., a Br
ID: 2381361 • Letter: W
Question
Was the junior accountant's analysis correct? Why or why not?
Lessee Ltd., a British company that applies IFRSs, leased equipment from Lessor Inc. on January 1, 2007, for a period of three years. Lease payments of $100,000 are due to Lessor Inc. each year. Other expenses (e.g.. insurance, taxes, maintenance) are also to be paid by Lessee Ltd. and amount to $2,000 per year. The lessor did not incur any initial direct costs. The lease contains no purchase or renewal options and the equipment reverts back to Lessor Inc. on the expiration of the lease. The remaining useful life of the equipment is four years. The fair value of the equipment at lease inception is $265,000. Lessee Ltd. has guaranteed $20,000 as the residual value at the end of the lease term. The salvage value of the equipment is expected to be $2,000 after the end of its economic life. The lessee's incremental borrowing rate is 11 percent (Lessor's implicit rate is 10 percent and is calculable by the lessee from the lease agreement). The junior accountant of Lessee Ltd. analyzed the assets under lease and prepared a computation. The senior accountant of Lessee Ltd. reviewed the analysis and the computation and prepared a separate analysis. As the finance controller, you were given both of the computations to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant are below. Present Value of the Lease Obligation Using the rate implicit in the lease (10 percent), the present value of the guaranteed residual value would be $15,026 ($20,000 x 0.7513). and the present value of the annual payments would be $24S.690 ($100,000 x 2.4869). Using the incremental borrowing rate (11 percent), the present value of the guaranteed residual value would be $14,624 ($20,000 x 0.7312). and the present value of the annual payments would be $244,370 ($100,000 x 2.4437). Computations by the Junior accountant: Since the equipment reverts back to Lessor Inc., it is an operating lease. Entries to be posted in Years 1, 2, and 3: Dr. Lease expense $100.000 Dr. Insurance expense $2,000 Cr. Cash $102,000 (Operating lease rental paid to Lessor Inc.)Explanation / Answer
The lease is an operating lease to the lessee and lessor because: 1. it does not transfer ownership, 2. it does not contain a bargain purchase option, 3. it does not cover at least 75% of the estimated economic life of the eqpt,(Life 7 yrs, Lease 3 yrs) 4. the present value of the lease payments is not at least 90% of the fair value of the leased eqpt. $100,000 Annual Lease Payments X PV of annuity due at 11% for 3 years ie $100,000 X 2.71252 = $271,252, which is more than $238,500 (90% X $265,000) So Criteria 4 fails. For operate Lease, At least one of the four criteria would have had to be satisfied for the lease to be classified as other than an operating lease. (b) Lessee’s Entries Lease Expense Dr 100,000 Insurance expense Dr 2000 Cash Cr 102,000 This entry is to be made for all 3 yrs of Lease period. So Jr Accountant's analysis was correct.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.