Aquarius Incorporated (AI) uses leases as a method of selling its products. In early 2011, AI completed construction of a passenger ferry for use between Manhattan and Staten Island. On April 1, 2011, the ferry was leased to the Manhattan Ferry Line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. Annual lease payments do not include executory costs. Other terms of the agreement are as follows:
Original Cost of the ferry $1,500,000
Fair Value of ferry at the lease date $2,107,102
Lease Payments (paid in advance) $225,000
Estimated residual value (unguaranteed) $78,000
Incremental borrowing rate – lessee $10%
Date of first lease payment April 1, 2011
Lease period 20 years
Compute the amount of financial revenue that will be earned over the lease term and the manufacturer’s profit that will be earned immediately by Aquarius. (11 points)
- Give the entry to record the signing of the lease on Aquarius’ books. (8 points)
- Compute the implicit rate of interest on the lease. (5 points)
- Give the journal entries necessary on Aquarius’ books to record the lease for the first three years, exclusive of the initial entry. Aquarius has a calendar accounting year.
- Indicate the balance of Lease Payments Receivable at December 31, 2013.
Truck Leasing Company (TLC) buys trucks for leasing to various delivery companies. On October 1, 2010, TLC leases a truck to Showman Delivery Company. The cost of the truck to TLC was $196,110, which approximated its fair value on the lease date. The lease payments stipulated in the lease are $33,000 per year in advance for the 10-year period of the lease. The payments include executory costs of $3,000 per year. The expected economic life of the equipment is also 10 years. The title to the equipment remains in the hands of TLC at the end of the lease term, although only nominal residual value is expected at that time. Showman incremental borrowing rate is 10%, and it uses the straight-line method of depreciation on all owned equipment. Both Showman and TLC have fiscal year ending September 30 and lease payments are made on this date.
Prepare the entries to record the lease and the first lease payment on the books of the lessor and lessee, assuming the lease meets the criteria of a direct financing lease for the lessor and a capital lease for the lessee. (20 points)
Compute the implicit rate of interest of the lessor. (5 points)
Give all entries required to account for the lease on both the lessee’s and lessor’s books for the fiscal years 2011, 2012, and 2013. (60 points)
Jacks Mining and Manufacturing Company (JMMC) leases from Emily Leasing Company three machines under the following operating lease terms:
- Machine 1: Lease period – 10 years, beginning April 1, 2005; lease peyments-$18,000 per year, payable in advance.
- Machine 2: Lease period – 10 years, beginning July 1, 2009, lease payments-$30,000 per year, payable in advance.
- Machine 3: Lease period – 15 years, beginning January 1, 2010, lease payments-$12,500 per year, payable in advance.
Required: Prepare the note to the 2011 financial statements that would be required to disclose the lease commitments of JMMC. JMMC’s accounting period is a calendar year.
Daniel Hardware Co. is considering alternative financing arrangements for equipment used in its warehouses. Besides purchasing the equipment outright, Daniel is also considering a lease. Accounting for the outright purchase is fairly straightforward, but because Daniel has not used equipment leases in the past, the accounting staff is less informed about the specific accounting rules for leases. The staff is aware of some lease rules related to a “90 percent of fair value,” “75 percent of useful life,” and “residual value deficiencies,” but they are unsure about the meanings of these terms in lease accounting. Daniel has asked you to conduct some research on these items related to lease capitalization criteria.
Provide codification references for your responses.
- a) What is the objective of lease classification criteria?
- b) An important element of evaluating leases is determining whether substantially all of the risks and rewards of ownership are transferred in the lease. How is “substantially all” defined in the authoritative literature?
- c) Besides the noncancelable term of the lease, name at least three other considerations in determining the “lease term.”
- d) A common issue in the accounting for leases concerns lease requirements that the lessee make up a residual value deficiency that is attributable to dmage, extraordinary wear and tera, or excessive usage (e.g., excessive mileage on a leased vehicle). Do these features constitute a lessee guarantee of the residual value such that the estimated residual value of the leased property at the end of the lease term should be included inminimum lease payments? Explain.