Class 11 Lease practice problem
Lease Practice Problem – sale-leaseback
Alice has an equipment that has appreciated in value in recent years. On January 1, 2013, this equipment has a carrying amount of $250,000 (with original cost of 500,000), and its fair value is $305,000. Alice sells this equipment to Superior Equipment Company for $305,000.
On the same day, Alice Company, the lessee, leases the same equipment back from Superior Equipment Company, the lessor, for 5 years, agreeing to pay $66,550 annually at the beginning of each year under the non-cancelable lease. The estimated economic life of this equipment is 10 years. The estimated residual value at the end of year 5 is $64,000 and is not guaranteed by Alice; at the end of year 10, it is $5,000. There is no bargain purchase option in the lease or any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. There is no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor and the collectability of the payments from the lessee is reasonably assured. Straight-line depreciation is considered the appropriate method by both companies. Required:
1. Identify the type of the lease involved for Alice and Superior Equipment and give reasons for your classifications.
2. Prepare appropriate journal entries for 2013 and 2014 for both the lessee and lessor.
3. If the residual value at the end of year 5 is guaranteed by Alice, identify the type of lease for both the lessee and lessor and briefly explain why. Prepare journal entries for 2013 and 2014 for the lessee and lessor. Also prepare the journal entries for the lessee and the lessor when the lessee pays the guaranteed residual value.
Note: please use calculator to compute present value or present value factors
Alice has an equipment that has appreciated in value in recent years. On January 1, 2013, this equipment has a carrying amount of $250,000 (with original cost of 500,000), and its fair value is $305,000. Alice sells this equipment to Superior Equipment Company for $305,000.
On the same day, Alice Company, the lessee, leases the same equipment back from Superior Equipment Company, the lessor, for 5 years, agreeing to pay $66,550 annually at the beginning of each year under the non-cancelable lease. The estimated economic life of this equipment is 10 years. The estimated residual value at the end of year 5 is $64,000 and is not guaranteed by Alice; at the end of year 10, it is $5,000. There is no bargain purchase option in the lease or any agreement to transfer ownership at the end of the lease to the lessee. The implicit interest rate is 12%. There is no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor and the collectability of the payments from the lessee is reasonably assured. Straight-line depreciation is considered the appropriate method by both companies. Required:
1. Identify the type of the lease involved for Alice and Superior Equipment and give reasons for your classifications.
2. Prepare appropriate journal entries for 2013 and 2014 for both the lessee and lessor.
3. If the residual value at the end of year 5 is guaranteed by Alice, identify the type of lease for both the lessee and lessor and briefly explain why. Prepare journal entries for 2013 and 2014 for the lessee and lessor. Also prepare the journal entries for the lessee and the lessor when the lessee pays the guaranteed residual value.
Note: please use calculator to compute present value or present value factors