Laura Leasing Company signs an agreement on January 1, 2017, to lease equipment
ID: 2549164 • Letter: L
Question
Laura Leasing Company signs an agreement on January 1, 2017, to lease equipment to Blossom Company. The following information relates to this agreement. 1. 2. 3. 4. 5. 6. The term of the non-cancelable lease is 3 years with no renewal option. The equipment has an estimated economic life of 5 years. The fair value of the asset at January 1, 2017, is $49,000. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $5,000, none of which is guaranteed. The agreement requires equal annual rental payments of $15,438 to the lessor, beginning on January 1, 2017. The lessee's incremental borrowing rate is 5%. The lessor's implicit rate is 4% and is unknown to the lessee. Blossom uses the straight-line depreciation method for all equipment. Assume that the expected residual value at the end of the lease is $10,000, such that the payments are $13,898. Click here to view the factor table. Prepare all of the journal entries for the lessee for 2017 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee's annual accounting period ends on December 31. (For calculation purposes, use 5 decimal places as displayed in the factor table provided and round answers to 0 decimal places, e.g. 5,265. Credit account titles are automatically indented when the amount is entered. Do not indent manually.) Account Titles and Explanation Debit Credit Date 1/1/17 (To record the lease) (To record lease liability) 12/31/17Explanation / Answer
Term of lease 3 yrs Fair value of asset on 01/01/2017 49,000.00 $ Residual value at end of 5 years 5,000.00 $ Annual lease payments (ALP) 15,438.00 $ Incremental rate of borrowing for lessee 5.00% 1) Calculation of present value of minimum lease payments (MLP) (using incremental borrowing rate) MLP Factor Fair value 01-Jan-17 15,438.00 1.00000 15,438.00 01-Jan-18 15,438.00 0.95238 14,702.86 01-Jan-19 15,438.00 0.90703 14,002.72 Present value of MLP 44,143.58 % of fair value given 90.09% As per IAS 17, a lease is considered to be a finance lease if at the inception of the lease, the present value of the minimum lease payments amount to at least substantially all of the fair value of the leased asset. (In my opinion, 90% of fair value is substantial part of the fair value) Since, the above condition is fulfilled, the lease is to be accounted for as a finance lease. (Also, if we compare the fair value less residual value amount , i.e., 49000-5000 = 44000$ with present value of MLP, the value is almost equal. But since the residual value is not gauranteed it cannot be taken into account for calculation PV of MLP) 2) Calculation of interest and principal amount The value to be accounted for asset at inception is to be lower of fair value or present value of MLPs, therefore, the recognition of the asset will be at 44,144 $ Opening Obligation advance lease payments in year obligation finance charge @ 5% capital repayment closing obligation 01-Jan-17 44,144.00 15,438.00 28,706.00 1,435.00 14,003.00 30,141.00 01-Jan-18 30,141.00 15,438.00 14,703.00 735.00 14,703.00 15,438.00 01-Jan-19 15,438.00 15,438.00 - - 15,438.00 - 3 Accounting enteries Debit Credit 01-Jan-17 Lease Equipment Dr. 44,144.00 To Obligation under lease 44,144.00 01-Jan-17 Obligation under lease Dr. 15,438.00 To Cash/Bank 15,438.00 31-Dec-17 Interest expense Dr. 1,435.00 To Accrued Interest - Obligation under lease 1,435.00 31-Dec-17 Depreciation Dr. 14,715.00 To Lease Equipment 14,715.00 (dep = 44144 $ / 3yr )
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