Chapter 15-Intermediate Accounting 2

refer to 15-3

$562,907 * 5.32948 = 3,000,000 PVADF n = 6, i = 3 What amounts are reported in balance sheet? 562,907 * 5.32948 =3,000,000 2. Liability Balance, June 30, 2018 3,000,000 June 30, 2018 reduction (562,907) Dec 31, 2018 reduction (441,052) December 31, 2018 = 1.996,041 Payment = 12/31/18 interest = (562,907-121,855) 3,000,000-562,907*.05 Right of Use Asset: 3,000,000-500,000 =2,500,000 3,000,000/3 X1/2 year What amounts are reported in the income statement? Depreciation or Amortization Expense: Interest Expense 6/30/18-12/31/18- 121,855 Interest expense for 2018 = 121,855 Amortization Expense for 2018 500,000 Total Expenses 500,000+121,855 = 621,855

On January 1, 2017, Nelson Co. leased a building to Wise Inc. The relevant information related to the lease is as follows: 1. the lease arrangement is for 10 years. the building is expected to have RI of 3,500,000(unguaranteed) 2. leased building cost of 4,000,000 and was purchased for cash on Jan 1, 2017 3. building-straight line 4.lease payments 275,000 per year 5. wise has incremental borrowing rate-8% 6. implicit rate is unknown Prepare journal entries for nelson in 2017

1/1/17-Dr. Cash(receive payment) 275,000 Cr. Unearned/Deferred Lease Revenue-liability-do not recognize this until year has gone by 12/31/17-Dr. Lease Revenue(unearned deferred) 275,000-the year has passed so its recognized Cr. Lease Revenue 275,000 Depreciation Expense 4 mil/50 years 80,000 Accumulated Depreciation 80,000 Nelson has physical asset on there books so therefore it is depreciation and not amortization

With selling profit entries

1/1/18-Dr. Lease Receivable Dr. Cost of Goods Sold Cr. Sales Revenue Cr. Equipment

2nd Payment

1/1/19 Dr. Cash Cr. LR Cr. IR

Lessee Journal Entries

Date of Inception-present value of lease payments 1/1/17-Dr. right of use asset 275,000*7.24689 = 1,992,895 PVADF, n = 10, i = 8%, Cr. lease payable 1,992,895 Dr. Lease Payable 275,000 Cr. Cash 275,000 12/31/17: Dr. Interest Expense 137,432 Cr. Interest Payable 137,432 Dr. Amortization Expense (payment - interest) 275,000-137,432) = 137,568 Cr. Right of Use Asset 137,568 Wise 2017: Interest Expense 137,432 + Amortization Expense 137,568 =275,000 = 2017 2018: 126,426 + 148,574 = 275,000 Lessor-Lease Revenue = payment Lessee-lease expense(total) = payment

Payment(on date of inception)

Dr. Cash Cr. Lease Receivable

1st Payment

Dr. Cash Cr. Lease Receivable Cr. Interest Receivable

Second Payment

Dr. Cash Cr. Lease Receivable Cr. Interest Receivable

Accrue Interest

Dr. Interest Receivable Cr. Interest Revenue

Accrue Interest

Dr. Interest Receivable Cr. Interest Revenue

1st payment(on date of inception)

Dr. Lease Liability Cr. Cash

2nd payment

Dr. Lease Liability Dr. Interest Payable Cr. Cash

Journal Entry for first and second payment

Dr. Lease Payable 100,000 Cr. Cash 100,000 Dr. Cash 100,000 Cr. Deferred Lease Revenue 100,000 Second Lease Payment: Dr. Interest Expense(10%*(348,685-100,000) 24,869 Dr. Lease Payable(difference) 75,131 Cr. Cash 100,000 Dr. Deferred Lease Revenue 100,000 Cr. Lease Revenue 100,000 Dr. Cash 100,000 Cr. Deferred Lease Revenue 100,000 Dr. Depreciation Expense (479,079/6) = 79.,847 Cr. Accumulated Depreciation 79,847

Lessor Journal Entries

Dr. Lease Receivable Cr. Equipment

15-8 lessor

Dr. Lease Receivable-lease balance Dr. COGS-should be given to you in the problem Cr. sales revenue-lease balance-present value*PVADF Cr. Equipment-cost of equipment Inception: Dr. Cash 15,000 Cr. Lease Receivable 15,000 Dr. Cash 15,000 Cr. Lease Receivable 13,058 Cr. Interest Revenue 1942

beginning of the lease journal entry

Dr. Right of Use Asset 384,685 Cr. Lease Payable 384,685

Accrue Interest

Dr. interest Expense Cr. Interest Payable

record the lease entry

Dr. right of use asset-right to use the asset is an asset and then we put our asset on our books-go under property, plant and equipment Cr. Lease Payable because a lessee has an asset on there books, we are going to amortitize it-depreciation-not a fixed asset then we use the term amortization instead of depreciation. We do this over the lease term or useful life-we do this if there is a transfer of ownership and use the useful life of the asset if ownership is not there transfer goes back to the lessor, so we only use the lease term when we don't have the bargain in option. Amount is the present value of the payments

Lease Classification

Finance/Sales Type lease Operating Lease sometimes the true nature of the contract is obvious-a 10 year noncancelable lease of a computer with a 10 year useful life, by which title passes to the lessee at the end of the lease term-represents a purchase-finance lease a 10 day rental of the same computer, with no passage of title to the lessee-rental legal ownership is irrelevant in the decision

Edison Leasing Corporation Quarterly Payments-15,000 at the beginning of each period Economic Life 2 years(8 quarterly periods) Fair Value-112,080 interest rate 8%

First take the 15,000 * n = 2*4 = 8 and I = 8/2= 4 Inception: 1/1/19-Dr. Rights of Use Asset-lease balance Cr. Lease Liability-lease balance 1st payment: Dr. Lease Payable-cash interest Cr. Cash-cash interest Dr. Interest Expense 1942 Dr. Lease Payable 13,058-d/I in balance Cr. Cash 15,000-cash interest 7/1/18-Dr. Interest Expense Dr. Lease Payable Cr. Cash Do this all the way through December 31 2019. Record Amortization Expense and rights of use asset at Dec 31, 2018 and December 31, 2019 E 15-7 differs

On January 1, 2018, Sans Sariff Publishers leased printing equipment from first lease corporation. First Lease Corp Purchased the equipment from CompuDee Corporation at a cost of $479,079. San Serifs Borrowing Rate is 10%. 4 annual payments of 100,000 beginning January 1 and at each December 31 from 2018-2020. The useful life is 6 years. Present Value is 348,685

How to get the present value: 100,000* 3.48685

book example page 835

Installment Note: Machinery 666,633 Note Payable 666,333 Finance Lease: Leased Machinery 666,633 Lease Payable 666,633

Reporting Lease Expense and Lease Revenue

Lessee: Interest Expense Amortization Expense. The lesee combines these two accounts into a single lease expense and reports a single 100,000 amount each year in its income statement

LeaseTerm

Renewal options generally fixed but must be reassessed if there is a significant change in circumstances

Finance Leases and Installment Notes Compared

Skill Graphics Purchased a package machine from barker corporation by issuing a 3 year installment note that required six semiannual installment payments of $139, 857

Example

Suppose instead of purchasing farmland for its fair value of $100,000, the farmland is leased for $20,000 per year for 5 years with the option at the end of the lease period to purchase it for an additional $25,000

What is the purchase option?

a provision in the lease contract that gives the lessee the option of purchasing the leased property at a specified exercised price this criteria is met if the exercise price is lower than the expected fair value of the property when the option becomes exercisable that the exercise of the option by the lessee appears reasonably certain at the beginning of the lease if option is certain, then we can have the lessee exercise the option and it will be a substance or borrowing transaction

Substance Over Form

account for a transaction based on the substance of a transaction

Discount Rate

because lease payments occur in future periods, we must consider the time value of money when evaluating the present value implicit in the lease agreement effective interest rate of return the lease payments provide under the lessor what if the lessee is unaware of the lessors rate?-use own borrowing rate -the lessee uses the interest rate implicit in the lease if known, otherwise the lessee uses its own incremental borrowing rate-went to a bank and borrowed money to finance the purchase of an asset

What are operating leases?

businesses too, lease assets under similar arrangements

Criteria 3

considers whether the asset is leased for the major part of its useful life

Variable Payments

contingent rents recognized when incurred rather than estimated at the beginning of the lease term

Alternative Use

does the specialized nature of the asset mean that it has no alternative use to the lessor at the end of the time?

Operating Leases

fundamental rights and responsibilities of ownership are retained by the lessor and that the lessee merely is using the asset temporarily operating leases are treated more as rental agreements

Criterion 5

if the underlying 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, then only the lessee can derive the usual risks and rewards of ownership of the asset

In substance purchase and borrowing?

if you are going to lease an asset, especially if it is a long term asset, your commiting to a string of payments over a long period of time the substance of the transaction is you are buying the asset and you are borrowing money to finance the purchase. lessor continues to have title to the property even though that is the form, substance is we are going to have the lease. In accounting, the lessor might have legal title to the property but the lessee puts the property on there books and lessor takes it off of the lessee's books if you are a lesee-finance lease lessor-sales type lease-with/without a selling profit operating leases-lessee and lessor

Recording Amortization of the Right of Use Asset

lease expense is recorded in a manner that is designed to mirror the straight line rental of the asset Interest Expense: 24,869 Amortization Expense 75,131 Lease Expense 100,000 Journal Entries: Dr. Interest Expense(10*384,685 - 100,000) Dr. Lease Payable 75,131 Cr. Cash 100,000

Amortization

lease payment/years Dr. Amortization Expense Cr. Rights of Use Asset

Criteria 4

lease payments have a total value that represents "substantially all of the asset's fair value, it's logical to identify the lease contract as equivalent to scale payments with a present value of 90% or more of the fair value of the underlying asset represent "substantially all of the fair value

Lease term

major part of the remaining economic life greater than or equal to 75% of economic life of the asset

What are the terms of the finance lease?

normally allow the lessee to direct the use of the asset in a way that the lessee receives substantially all of the remaining benefits from the asset creates obligations for the lessee that are similar to those that financing the purchase of an asset would impose Operating Lease-does not have these characteristics

bargain purchase option

option to purchase the asset at a price substantially below the projected fair value of the asset at the end of the lease term if you have an asset of 100,000 and you buy the asset however you buy the asset for 25,000 you can exercise it

Recording amortization

over the lease term Dr. Amortization Expense(outstanding balance/# of years)

What is a lessor?

owner

Finance Lease Classification

ownership of the asset transfers to the lessee contains a purchase option that the lessee is reasonably certain to exercise the lease term is for "the major part" of the remaining economic life of the underlying asset the present value of the total lease payments equals or exceeds substantially all of the fair value of the underlying asset the underlying 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

Recording Interest Expense/Interest Revenue

recorded at the effective interest rate

Present Value of Payments

represents substantially all of the assets fair value greater than or equal to 90% of the assets fair value

Criteria 1

since our objective is to determine whether the lessor has sold the asset to the lessee, the first criterion is self evident. If legal title passes to the lessee, or at the end of the lease term, ownership attributes are transferred title of property transferred to the lessee at the end of the term

Short term lease

term is 12 months or less lessee can record lease payments as expense

How do we account for an operating lease?

the lessee still records an asset and a liability at the beginning of the lease Sans Seriff, although not having purchased the asset via the lease agreement still has acquired the right to use asset for 4 years of the assets 6 year useful life. operating lease-non debt liability lessor does not record a lease receivable . The lessor views an operating lease as simply renting the asset to the lessee and records rent revenue on a straight line basis

Recording Interest Expense/Interest Revenue

the lessee will report a single lease expense 1. interest expense on the lease liability 2.amortization of the right of use asset

What is a lessee?

user, agreement between two parties to allow the use of an asset over a specific period of time(the lease term) in return for periodic payments, user of the property