Leases
Practice as You Learn
Intermediate Accounting 2
Practice as You Learn
Problem 1 – Finance / Sales-Type Lease without a Sales Profit and No Residual Value
Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset is $40,000 (also the asset’s fair value on the lease date). The lease term is 4 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The asset has no residual value. The effective rate of the lease is 8%.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.
Answer
80% of the life is substantially all of the useful life of the asset
The PV of the minimum lease payments is 100% of the fair value of the asset
A. Calculate the lease payment:
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | 0 |
| = Payments cover | 40,000 |
| / PV factor of annuity due | 3.5771 |
| = Annual Payment | 11,182 |
B. Amortization Schedule:
| Payment Date |
Payments | 8% Interest |
Decrease | Outstanding Balance |
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $11,182 | $11,182 | $28,818 | |
| 12/31/X1 | $11,182 | $2,305 | $ 8,877 | $19,941 |
| 12/31/X2 | $11,182 | $1,595 | $ 9,587 | $10,355 |
| 12/31/X3 | $11,182 | $ 827 | $10,355 | $ 0 |
C. Journal entries 1st Year
| Lessor | Lessee | |||
| Lease Receivable $40,000 | Right of Use Asset $40,000 | |||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cash $11,182 | Lease Payable $11,182 | |||
| Lease Receivable $11,182 | Cash $11,182 | |||
| Cash $11,182 | Interest Expense $2,305 | |||
| Lease Receivable $8,877 | Lease Payable $8,877 | |||
| Interest Revenue $2,305 | Cash $11,182 | |||
| Amortization Expense $10,000 | ||||
| Right to Use Asset $10,000 | ||||
Problem 2 – Finance / Sales-Type Lease with Sales Profit and No Residual Value
Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset is $30,000 and the asset’s fair value on the lease date is $40,000. The lease term is 4 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The asset has no residual value. The effective rate of the lease is 8%.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.
Answer
$40,000 lessee’s cost (FMV)
– $30,000 lessor’s cost
= $10,000 profit
80% of the life is substantially all of the useful life of the asset
The PV of the minimum lease payments is 100% of the fair value of the asset
A. Calculate the lease payment:
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | 0 |
| = Payments cover | 40,000 |
| / PV factor of annuity due | 3.5771 |
| = Annual Payment | 11,182 |
B. Amortization Schedule:
| Payment Date |
Payments | 8% Interest |
Decrease | Outstanding Balance |
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $11,182 | $11,182 | $28,818 | |
| 12/31/X1 | $11,182 | $2,305 | $ 8,877 | $19,941 |
| 12/31/X2 | $11,182 | $1,595 | $ 9,587 | $10,355 |
| 12/31/X3 | $11,182 | $ 827 | $10,355 | $ 0 |
C. Journal entries 1st Year
| Lessor | Lessee | |||
| 1/1/20X1: Lease Receivable $40,000 |
Right of Use Asset $40,000 |
|||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cost of Goods Sold $30,000 | ||||
|
Asset $30,000
|
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| Cash $11,182 | Lease Payable $11,182 | |||
| Lease Receivable $11,182 | Cash $11,182 | |||
| 12/31/20X1: | ||||
| Cash $11,182 | Interest Expense $2,305 | |||
| Lease Receivable $8,877 | Lease Payable $8,877 | |||
| Interest Revenue $2,305 | Cash $11,182 | |||
| Amortization Expense $10,000 | ||||
| Right to Use Asset $10,000 | ||||
Problem 3. Finance / Sales-Type Lease without Sales Profit with Guaranteed Residual Value
Same lease as problem 1, and the lease has a $2,000 guaranteed residual value.
At the end of the lease the actual fair market value of the asset is $1,500.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease
D. Record the return of the asset at the end of the lease.
Answer
A. Calculate the lease payment:
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | (1,470) |
| = Payments cover | 38,530 |
| / PV factor of annuity due | 3.5771 |
| = Annual Payment | 10,771 |
Use 8% / 4p
2,000 x PV of $1 of 0.7350 = 1,470
The payment is lower because it does not have to cover the guaranteed RV.
This amount will be paid when the asset is returned, either with the asset or with cash.
B. Amortization Table:
| Payment Date |
Payments | 8% Interest |
Decrease | Outstanding Balance |
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $10,771 | $10,771 | $29,229 | |
| 12/31/X1 | $10,771 | $2,338 | $ 8,433 | $20,796 |
| 12/31/X2 | $10,771 | $1,664 | $ 9,107 | $11,689 |
| 12/31/X3 | $10,771 | $934 | $ 9,837 | $ 1,852 |
| 12/31/X3 | $ 2,000 | $148 | $ 1,852 | $ 0 |
C. Journal entries 1st Year
| Lessor | Lessee | |||
| Lease Receivable $40,000 | Right of Use Asset $40,000 | |||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cash $10,771 | Lease Payable $10,771 | |||
| Lease Receivable $10,771 | Cash $10,771 | |||
| Cash $10,771 | Interest Expense $2,338 | |||
| Lease Receivable $8,433 | Lease Payable $8,433 | |||
| Interest Revenue $2,338 | Cash $10,771 | |||
| Amortization Expense $10,000 | ||||
| Right to Use Asset $10,000 | ||||
| ($40,000 / 4 years) | ||||
D. Journal Entries for Asset Return at the End of the Lease
| Lessor: | ||||
| Cash $ 500 GTD RV | ||||
| Asset $1,500 FMV | ||||
| Lease Receivable $1,852 | ||||
| Interest Revenue $ 148 | ||||
| Lessee: | ||||
| Loss on Lease $500 | ||||
| Cash $500 | ||||
Problem 4. Finance / Sales-type Lease without Sales Profit with Unguaranteed Residual Value
Same lease as problem 1, and the lease has a $2,000 unguaranteed residual value.
At the end of the lease fair market value of the asset is $1,500.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease and the second payment
D. Record the return of the asset at the end of the lease.
Answer
A. Calculate the lease payment:
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | (1,470) |
| = Payments cover | 38,530 |
| / PV factor of annuity due | 3.5771 |
| = Annual Payment | 10,771 |
Use 8% / 4p
B. Amortization Table:
| Payment Date |
Payments | 8% Interest |
Decrease | Outstanding Balance |
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $10,771 | $10,771 | $29,229 | |
| 12/31/X1 | $10,771 | $2,338 | $ 8,433 | $20,796 |
| 12/31/X2 | $10,771 | $1,664 | $ 9,107 | $11,689 |
| 12/31/X3 | $10,771 | $ 934 | $ 9,837 | $ 1,852 |
| 12/31/X3 | $ 2,000 | $ 148 | $ 1,852 | $ 0 |
C. Journal entries 1st Year
| Lessor | Lessee | |||
| Lease Receivable $40,000 | Right of Use Asset $40,000 | |||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cash $10,771 | Lease Payable $10,771 | |||
| Lease Receivable $10,771 | Cash $10,771 | |||
| Cash $10,771 | Interest Expense $2,338 | |||
| Lease Receivable $8,433 | Lease Payable $8,433 | |||
| Interest Revenue $2,338 | Cash $10,771 | |||
| Amortization Expense $10,000 | ||||
| Right to Use Asset $10,000 | ||||
| ($40,000 / 4 years) | ||||
D. Journal Entries for Asset Return at the End of the Lease
| Lessor: | ||||
| Loss on lease $ 500 | ||||
| Asset $1,500 | ||||
| Lease Receivable $1,852 | ||||
| Interest Revenue $ 148 | ||||
The lessee did not guarantee the difference between the RV and FMV and does not pay this difference. The lessor records the asset at FMV and the difference as a loss in the period the asset is returned.
Problem 5. Finance / Sales-type without Sales Profit with Bargain Purchase Option
Assume the same lease as in problems 1. and the lease has a bargain purchase option of $6,000 at the end of 2 years. The asset has an economic useful life of 6 years.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease and the second payment
D. Record the exercise of the bargain purchase option that ends the lease.
Answer
A. Calculate the lease payment:
Calculate the payment using 2 years as the period. You assume the buyout will occur and the lease will end with the purchase. The lease term is 2 years.
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | (5,134) |
| = Payments cover | 34,866 |
| / PV factor of annuity due | 1.9259 |
| = Annual Payment | 18,099 |
Use 8% / 2p
B. Amortization Table:
| Payment Date |
Payments | 8% Interest |
Decrease | Outstanding Balance |
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $18,099 | $18,099 | $21,901 | |
| 12/31/X1 | $18,099 | $1,752 | $ 16,347 | $ 5,554 |
| 12/31/X2 | $ 6,000 | $ 446 | $ 5,554 | $ 0 |
C. Journal entries 1st Year
| Lessor | Lessee | |||
| Lease Receivable $40,000 | Right of Use Asset $40,000 | |||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cash $18,099 | Lease Payable $18,099 | |||
| Lease Receivable $18,099 | Cash $18,099 | |||
| Cash $18,099 | Interest Expense $ 1,752 | |||
| Lease Receivable $16,347 | Lease Payable $16,347 | |||
| Interest Revenue $ 1,752 | Cash $18,099 | |||
| Amortization Expense $8,000 | ||||
| Right to Use Asset $8,000 | ||||
| ($40,000 / 5 yr life of asset) | ||||
D. Journal Entries for Asset Return at the End of the Lease
| Lessor: | ||||
| Loss on lease $6,000 | ||||
| Asset $5,554 | ||||
| Lease Receivable $ 446 | ||||
| Lessee: | ||||
| Lease Liability $5,554 | ||||
| Interest Expense $ 446 | ||||
| Cash $6,000 | ||||
The lessee did not guarantee the difference between the RV and FMV and does not pay this difference. The lessor records the asset at FMV and the difference as a loss in the period the asset is returned.
Problem 6. Sale-Leaseback Finance / Sales-type without Sales Profit
Lessee sells an asset for $40,000 to another company and then leases it back at the FMV of $40,000. The original cost of the asset to the lessee was $30,000 and accumulated depreciation at the time of the sale is $10,000. The lessee enters into a 4-year, 8% lease agreement with no residual value with the buyer.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.
Answer
A. Calculate the lease payment:
| Cost or FMV of asset | 40,000 |
| – Present value of RV or BPO | 0 |
| = Payments cover | 40,000 |
| / PV factor of annuity due | 3.5771 |
| = Annual Payment | 11,182 |
Use 8% / 4p
B. Amortization Table:
| Payment Date |
Payments | 8% Interest |
Decrease |
Outstanding
|
| 1/1/20X1 | $40,000 | |||
| 1/1/20X1 | $11,182 | $11,182 | $28,818 | |
| 12/31/X1 | $11,182 | $2,305 | $ 8,877 | $19,941 |
| 12/31/X2 | $11,182 | $1,595 | $ 9,587 | $10,355 |
| 12/31/X3 | $11,182 | $ 827 | $10,355 | $ 0 |
C. Journal entries 1st Year
1st: Record the purchase and the sale of the asset:
| Lessor – Buyer | Lessee – Seller | |||
| Lease Receivable $40,000 | Cash $40,000 | |||
| Asset $40,000 | Accumulated Depreciation $10,000 | |||
| Asset $30,000 | ||||
| Gain on sale of asset $20,000 | ||||
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Lessor – Buyer
|
Lessee – Seller
|
|||
| Lease Receivable $40,000 | Right of Use Asset $40,000 | |||
| Asset $40,000 | Lease Payable $40,000 | |||
| Cash $11,182 | Lease Payable $11,182 | |||
| Lease Receivable $11,182 | Cash $11,182 | |||
| Cash $11,182 | Interest Expense $2,305 | |||
| Lease Receivable $8,877 | Lease Payable $8,877 | |||
| Interest Revenue $2,305 | Cash $11,182 | |||
| Amortization Expense $10,000 | ||||
| Right to Use Asset $10,000 | ||||
Problem 7. Operating Lease
Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset (and PV of minimum lease payments) is $10,000 and the asset’s fair value on the lease date is $50,000. The lease term is 2 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The agreement states no residual value. The effective rate of the lease is 8%. The lessor intends to lease the asset again after this lease ends.
A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all journal entries for the first year of the lease.
Answer
A. Calculate the lease payment:
| Cost of asset | 10,000 |
| – Present value of RV or BPO | 0 |
| = Payments cover | 10,000 |
| / PV factor of annuity due | 1.92593 |
| = Annual Payment | 5,192 |
Use 8% / 4p
B. Amortization Table:
| Payment Date |
Payments | 8% Interest |
Decrease |
Outstanding
|
| 1/1/20X1 | $10,000 | |||
| 1/1/20X1 | $5,192 | $5,192 | $ 4,808 | |
| 12/31/X1 | $5,192 | $385 | $4,808 | $ 0 |
C. Journal entries 1st Year
1st: Record the purchase and the sale of the asset:
| Lessor | Lessee | |
| Beginning of lease: | ||
| Right of Use Asset $10,000 | ||
| No entry | Lease Payable $10,000 | |
| Initial payment at beginning of lease: | ||
| Cash $5,192 | Lease Payable $5,192 | |
| Deferred Revenue $5,192 | Cash $5,192 | |
| End of year: | ||
| Deferred Revenue $5,192 | Interest Expense $ 384 | |
| Lease Revenue $5,192 | Lease Payable $4,808 | |
| Cash $5,192 | ||
| Cash $5,192 | ||
| Deferred Revenue $5,192 | ||
| Depreciation Expense $10,000 | Amortization Expense $5,000 | |
| Accumulated Depreciation $10,000 | Right of Use Asset $5,000 | |
| (Cost / Useful life) | (PV of MLP / useful life) | |
| $10,000 / 2 years | ||