Blue Corporation leased equipment to Larkspur, Inc. on January 1, 2017. The leas
ID: 2544307 • Letter: B
Question
Blue Corporation leased equipment to Larkspur, Inc. on January 1, 2017. The lease agreement called for annual rental payments of $1,171 at the beginning of each year of the 3-year lease. The equipment has an economic useful life of 7 years, a fair value of $7,600, a book value of $5,600, and Blue expects a residual value of $5,100 at the end of the lease term. Blue set the lease payments with the intent of earning a 6% return, though Larkspur is unaware of the rate implicit in the lease and has an incremental borrowing rate of 8%. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature. Determine the nature of the lease to both Blue and Larkspur. The lease is a/an lease to Larkspur. The lease is a/an lease to Blue. Prepare all necessary journal entries for Larkspur in 2017. Date Account Titles and Explanation Debit Credit (To record the lease) To record lease liability) 12/31/17Explanation / Answer
A) The lease is an Finance Lease for Blue corporation and Larkspur both. So condition 5 is met so it is regarded as an Finance lease.
A lease shall be considered as a Finance lease if ANY of the below conditions met(Under US GAAP):-
1) Ownership of the asset is transferred to the lessee at the end of the lease term.
2) The lease grants the lessee an option to purchase the asset and the lessee is reasonably certain to exercise the option.
3) The asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
4) The lease term is for the major part of the remaining economic life of the underlying asset (75% of the asset's estimated useful life or greater).
5) The present value of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the asset (90% of the total original cost of the equipment).
Present value of Minimum lease payment + Residual Value=> Fair value of an Asset
1171+1171*100/110.06+1171*100*100/110.06*110.06
1171+1063+967+5100(Residual value)=8301 which is greater than fair value ($5100)
B) Journal Entries
As at 01.01.2017
Equipment A/c Dr $7600
To Lease liability Cr $7600
Fair Value or Minumum lease payment(MLP) which ever is lower
Calculation of MLP
1171+1171*100/110.08+1171*100*100/110.08*110.08
1171+1064+958+5100=8293
Lease liability A/c Dr $1171
To Bank Cr $1171
As at 31st December 2017
Interest A/c Dr $608
To Lease liability A/c $608(7600*8/100)
C) Commissons of $ 400 would be capistalised under the asset so right of use asset this $ 400 would come.
For lease liability prepayment of $ 700 this would deceased the lease liability and insurance payment of $200 every year inceased the lease liability.
So net Increase or decrease would be:-
Insurance 200*3= $600-$700= Net Decrease in lease liability would be $100.
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