Problem 21A-17 Oriole Inc. leased a new crane to Cheyenne Construction under a 5

Question

Problem 21A-17 Oriole Inc. leased a new crane to Cheyenne Construction under a 5-year, non-cancelable contract starting January 1, 2017. Terms of the lease require payments of $46,000 each January 1, starting January 1, 2017. The crane has an estimated life of 7 years, a fair value of $230,000, and a cost to Oriole of $230,000. The estimated fair value of the crane is expected to be $45,000 (unguaranteed) at the end of the lease term. No bargain purchase or renewal options are included in the contract, and it is not a specialized asset. Both Oriole and Cheyenne adjust and close books annually at December 31. Collectibility of the lease payments is probable. Cheyenne's incremental borrowing rate is 8%, and Oriole's implicit interest rate of 8% is known to Cheyenne. Click here to view factor tables Prepare all the entries related to the lease contract and leased asset for the year 2017 for the lessee and lessor, assuming Cheyenne uses straight-line amortization for all similar leased assets, and Oriole depreciates the asset on a straight-line basis with a salvage value of $12,000. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter O for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25125 and the final answer to O decimal places e.g. 58,972.) Date Account Titles and Explanation Debit Credit Lessee's Entries (To record lease.) (To record lease payment.) 12/31/17 (To record interest and amortization expense.)

Explanation / Answer

Solution:

Firstly lets calculate present value of minimum lease payment

year lease payment discount rate @ 8% present value

0 46000 1 46000

1 46000 0.92592 42592 (since the payment is to be made on the begining of the year)

2 46000 0.85733 39437

3 46000 0.79383 36516

4 46000 0.73502 33811

5 46000 0.68058 31306

6 46000 0.630169 29987

total 259649

leased asset as well as liability for lease should be recognised at the lower of

1. fair value of leased asset at the inception of lease or

2) present value of minimum lease payment from the lessee point of view.

whichever is lower

here in this case fair value ($230,000) is lpwer then the present value of minimum lease payment ($259649)

so lease liability will be capitalised as $230,000

Lessee's entries

Date Entry debit credit

1/1/2017 crane A/c Dr 230,000

To, lease liability A/c 230,000

(Being lease liability recorded)

1/1/2017 finance charges a/c Dr. 18,400

(230000*8% = 18400)

To, Bank A/c 18400

(Being Finance charges Paid)

1/1/2017 lease liability A/c Dr. 27600

(46000 - 18400 = 27600)

To, Oriole Inc. a/c 27600

( being lease liability reduced)

12/21/17 Profit & loss A/c Dr. 51257

To, finance charges A/c 18400

To, amortization A/c (230000/7) 32857

Lessor Entries

Date Entry Debit Credit

1/1/2017 no entry required for expense record as there is no expenses

1/1/2017 depreciation A/c dr. 31143

(230000 - 12000/7)

To, crane A/c 31143

( being depreciation recorded)

12/31/2017 Bank A/c Dr. 46000

To, cheyenne construction A/c 46000

( being lease revenue recorede)   

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