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ACCT3103 - Intermediate Financial Accounting II
Assignment 3 part 2 (lessor)
Question 1 (Lease with guaranteed residual value – from lessor’s perspective)
On January 1, 2024, Pedro Industries leased equipment to Kylie Co. for a four-year period, at which time possession of the leased asset will revert back to Pedro. The equipment cost Pedro $365,760 and has an expected useful life of six years. Its normal sales price is $365,760. The lessee-guaranteed residual value at the end of the lease is $25,000, which is the amount Kylie expects to pay at the end of the lease. Equal payments under the lease are $100,000 each year, payable in advance on December 31 each year except for the first one on January 1, 2024. Kylie’s incremental borrowing rate is 12%. Kylie knows the interest rate implicit in the least payments is 10%. Both companies use straight-line depreciation.
Required: 1. Show how Pedro calculated the $100,000 annual lease payments. 2. What is the nature of this lease to Pedro (the lessor)? Explain. 3. Prepare the appropriate entries for Pedro (the lessor) to record the lease and the lease payment at its inception. Show calculations. Question 2 (Lease with initial direct costs – from lessor’s perspective) On January 1, 2023, Copper Leasing Company leased equipment to Crystal Corporation for a 6- year period, at which time possession of the leased equipment will revert back to Copper Leasing Company. The lease is noncancelable. The lease terms do not provide for transfer of legal title, do not contain a bargain purchase option, and do not require the lessee to guarantee a residual value. Initial direct costs of negotiating and consummating the completed lease transaction incurred by Copper Leasing Company on January 1, 2023 were $13,000. The equipment, which has expected useful life of 6 years and expected residual value of $20,000, cost Copper Leasing Company $275,000 to manufacture. Its normal sales price was $390,000 on January 1, 2023. Equal payments under the lease are $68,045 and are due on January 1 of each year. The first payment was made on January 1, 2023. Collectibility of the remaining lease payments is reasonably assured, and Copper Leasing Company has no material cost uncertainties. Crystal’s incremental borrowing rate is 6%. Crystal knows that the interest rate implicit in the leasing payments is 4%. Both companies use straight-line depreciation.
Required: 4. What is the nature of this lease to Copper Leasing Company (the lessor)? Explain. 5. Prepare the appropriate entries for Copper Leasing Company (the lessor) to record the lease and the lease payment at its inception. Show calculations. 6. Determine the total amount of lease-related income Copper Leasing Company (the lessor) will report for the year 2023.
