Communication Case 15–2 Classification issues; lessee accounting; group interact
ID: 2577867 • Letter: C
Question
Communication Case 15–2 Classification issues; lessee accounting; group interaction LO15-12, LO15-20, LO15-30, LO15-60, LO15-70 Interstate Automobiles Corporation leased 40 vans to VIP Transport under a four-year noncancelable lease on January 1, 2018. Information concerning the lease and the vans follows: a. Equal annual lease payments of $300,000 are due on January 1, 2018, and thereafter on December 31 each year. The first payment was made January 1, 2018. Interstate's implicit interest rate is 10% and known by VIP. b. VIP has the option to purchase all of the vans at the end of the lease for a total of $290,000. The vans' estimated residual value is $300,000 at the end of the lease term and $50,000 at the end of 7 years, the estimated life of each van. c. VIP estimates the fair value of the vans to be $1,240,000. Interstate's cost was $1,050,000. d. VIP's incremental borrowing rate is 9%. e. VIP will pay the maintenance fees not included in the annual lease payments of $1,000 per year. The depreciation method is straight-line. Your instructor will divide the class into two to six groups depending on the size of the class. The mission of your group is to assess the proper recording and reporting of the lease described. Required: 1. Each group member should deliberate the situation independently and draft a tentative argument prior to the class session for which the case is assigned. 2. In class, each group will meet for 10 to 15 minutes in different areas of the classroom. During that meeting, group members will take turns sharing their suggestions for the purpose of arriving at a single group treatment. 3. After the allotted time, a spokesperson for each group (selected during the group meetings) will share the group's solution with the class. The goal of the class is to incorporate the views of each group into a consensus approach to the situation. Specifically, you should address: a. Identify potential advantages to VIP of leasing the vans rather than purchasing them. b. How should the lease be classified by VIP? by Interstate? c. Regardless of your response to previous requirements, suppose VIP recorded the lease on January 1, 2018, as a finance lease in the amount of $1,100,000. What would be the appropriate journal entries related to the finance lease for the second lease payment on December 31, 2018?Explanation / Answer
a) Below are the advantages of leasing an assets rather than purchase
1)To purchase asset company needs huge money or capital, which can be avoided by paying regular lease payments if assets is leased.
2) Leasing an asset does not need huge capital, as the lease payment is spread over few years thus one time. huge payment for purchasing assets is avoided and company can manage consistent working capital.
3) Yearly lease payments are operating expenses, this expenses can debited to Profit and loss account.
4) In case of capital lease, lessee can depreciate the leased asset over its lease period, this is an additional expenses along with lease payment.
5) Though the owner of asset is Lessee but the owner ship rights is not passed to lessee until lessee purchase assets, thus reducing the risk of assets becoming outdated.
b) Lease should be classified as Capital Lease, a) as the lease the present value of the minimum lease rentals is equal to or greater than 90% of the fair value of the leased asset and b) lessee has an option to buy asset at the end of the lease period.
c) Calculation of present value of minimum lease payment.
Minimum Lease payment
PV Factor
Present Value
$3,00,000
0.9091
$2,72,727
$3,00,000
0.8264
$2,47,934
$3,00,000
0.7513
$2,25,394
$3,00,000
0.6830
$2,04,904
$12,00,000
$9,50,960
Statement showing apportionment of minimum lease payment
Year
Minimum Lease payment
Opening Receivable
Finance charges (interest)
Principal payment (Capital recovery)
Balance Receivable
1
$3,00,000
$9,50,960
$95,096
$2,04,904
$7,46,056
2
$3,00,000
$7,46,056
$74,606
$2,25,394
$5,20,661
3
$3,00,000
$5,20,661
$52,066
$2,47,934
$2,72,727
4
$3,00,000
$2,72,727
$27,273
$2,72,727
$0
Journal entry in VIP books on December 31, 2018
Lease rent - Debit $300,000
To Finance charges payable - Credit $74,606
(interest charges)
To Lease liability payable - Credit $2,25,394
(Being lease liability and interest charges payable for 2nd year on December 31, 2018)
Finance charges payable - Debit $74,606
(interest charges)
To Lease liability payable - Debit $2,25,394
To Cash - Credit $300,000
(being lease payment for 2nd year paid off)
Minimum Lease payment
PV Factor
Present Value
$3,00,000
0.9091
$2,72,727
$3,00,000
0.8264
$2,47,934
$3,00,000
0.7513
$2,25,394
$3,00,000
0.6830
$2,04,904
$12,00,000
$9,50,960
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