3 1-1-08, Kimberly-Clark Corp. signs 10-year, non-cancelable lease agreement to lease a storage building fromSheffield Storage Co. KC is LESSEE.Equal rent payments of $72,000 starting 1/1/08FMV of building is $440,000.Blding has economic life of 12 years, with Unguaranteed R.V. of $10,000. ST-LINE depreciation.NON-renewable lease. Building reverts to lessor at termination of lease (THUS NO BPO).KC (LESSEE’S) incremental borrowing rate 12% annual.LESSOR’S rate is unknown.Yearly rent payment includes $2, of executory costs related to taxes on property.Instructions: Prepare journal entries on LESSEE’s BOOKSto reflect signing lease and payments/expenses for 08 and 09.Year end 12/31.
4 EXECUTORY COSTS? Expenses of ownership and use (e.g., insurance, tax, maintenance).How are they accounted for in an OPERATING LEASE?Paid by lessor and recovered in periodic rent payments.
5 EXECUTORY COSTS? How are they accounted for in a capital lease? LESSOR LESSEEIf lessor retains responsibilityfor paymentIf paid directly by lessee tothe third partyDON’T capitalize intoPV of minimum lease payments;executory costs subtractedfrom lease payment beforePV min lease payments calculatedNo need to adjust the rentpayment because it doesn’tinclude the executory costs.
6 How much then are the yearly rent payments? Capitalized amount of the lease:Yearly payment $ 72,000.00Executory costs 2,470.51Minimum annual lease payment $69,529.49What is the PRESENT VALUE of the minimum lease payments?Present value of minimum lease payments$69, X = $440,000.0010 years at 12%
7 1/1/08 Leased Asset 440,000.00 Lease Liability 440,000.00 What entry records the lease obligation for the LESSEE?1/1/08 Leased Asset 440,000.00 Lease Liability 440,000.00What entry records the first lease payment?1/1/08 Executory Costs—Property Taxes 2,470.51Lease Liability 69,529.49Cash 72,000.00
8 What other entries are needed for the LESSEE? DEPRECIATION12/31/05 Depreciation Expense 44,000.00 Accumulated Depreciation—Capital Leases 44,000.00($440,000 ÷ 10)* Don’t subtract salvage because its unguaranteed and no transfer of ownership.INTERESTtable next slide.
9 Schedule 1 Kimberly-Clark Paper Co. Lease Amortization Schedule (Lessee)Annual Payment Reduction BalanceLess of Lease of LeaseDate Executory Costs Interest (12%) Obligation Obligation1/1/ $440,000.001/1/08 $69, $69, ,470.511/1/09 69, $44, , ,397.481/1/10 69, , , ,315.69INTEREST for 200812/31/08 Interest Expense …………….. 44,456.46accrued Lease Liability (int/p) 44,456.46* payment made in cash on 1/1/09
12 a. Prepare entries for CASTLE (LESSOR) for 2008 and 2009 Castle Leasing Co. signs lease on to lease electronicequipment to Jan Way Co.2 year leasePayments at END of year.BPO for $16,000 at termination of lease.Cost/FMV of equipment is $160,000 to Castle.Economic life is 2 years.Residual value is $16,000Executory costs of $5,000/yr paid by Jan Way (LESSEE)Castle leasing desires 10% return.Collectibility of payments reasonably predictable and no important uncertainties surround costs yet to be incurred.
13 How much is the lease payment? LESSOR figures this out. The formula:PV of min lease = (Rent x factor) + (BPO x factor)$160,000= (Rent x What Rate?)FMV usually same thingRULE ON WHAT RATE TO USE FOR DISCOUNTINGLESSEELESSORUses the lower of his/her rate or the lessors;To find leased asset.Uses his/her own rate.
14 How much is the lease payment? LESSOR figures this out. The formula:PV of min lease = (Rent x factor) + (BPO x factor)$160,000= (Rent x What Rate?)FMV usually same thingLessor wants to earn 10%
15 How much is the lease payment? The formula:PV of min lease = (Rent x factor) + (BPO x factor)$160,000= (Rent x )+ ($16,000 X )Table 6-4 (2 10%; ordinary annuity)Table 6-2 (2 10%; lump sum)
16 RENT = $84,571.26 How much is the lease payment? The formula: PV of min lease = (Rent x factor) + (BPO x factor)$160,000= (Rent x )+ ($16,000 X )RENT = $84,571.26Table 6-4 (2 10%; ordinary annuity)Table 6-3 (2 10%; lump sum)
17 How much is the balance of lease receivable? $160,000 (same as PV of lease)
18 What does the interest table look like? Castle Leasing Company (Lessor)Lease Amortization ScheduleAnnual Payment Interest NetLease On Net Investment NetDate Investment Recovery Investment1/1/ $160,000.0012/31/08 $84, $16, $68, ,428.7412/31/ , ,142.52* 75, ,000.00$25,142.52*Difference of $.35 due to rounding.
19 Entry on 1/1/08 to initiate lease LESSOR (a) 1/1/08 Lease Payments Receivable 160,000Equipment 160,000.00Entries on 12/31/08To record lease receipt.Cash ($84, $5,000) 89,571.26Executory CostsPayable ,000.00Lease Receivable ,571.26Interest Revenue ,000.00
20 Executory Costs Payable 5,000.00 Lease Payments Receivable 75,428.74 12/31/09 Cash 89,571.26Executory Costs Payable 5,000.00Lease Payments Receivable 75,428.74Interest Revenue ,142.52B. If Jan Way uses BPO, what journal entry reflects the sale?Cash…………….. $16,000Lease Payments Receivable…. $16,000T-account analysis of Lease Receivable next slide.
21 Lease Receivable Life Lease Receivable $160,000 $68,571.26 $75,428.74 $16,000This is theBPO
23 Crosley Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, The lease is for an 8-year period and requires equal annualpayments of $35,013 at the beginning of each year.The first payment is received on January 1, Crosley had purchased themachine during 2006 for $160,000. Collectibility of lease payments isreasonably predictable, and no important uncertainties surround the amountof costs yet to be incurred by Crosley. Crosley set the annual rental to ensurean 11% rate of return. The machine has an economic life of 10 years withno residual value and reverts to Crosley at the termination of the lease.(a) Compute the amount of the LEASE RECEIVABLE.$35,013 X = $200,001
24 (b) Prepare all necessary journal entries for Crosley for 2007. Entry to record the lease at its inception for CrosleyLease payments receivable..... $200,001Cost of goods sold ,000Sales $200,001 (FMV)Inventory (equipment) $160,000 (book)
25 Entry to record the first lease payment (receipt) Cash $35,013Lease payments receivable $35,013Entry to record interest revenue adjustment.($200,001 - $35,013) = $164,987 x .11= $18,148Interest Receivable $18,148Interest revenue $18,148
27 Noncancellable lease between Mike Mooney Leasing (OR) and Denise Rode (EE). Inception (May 1, 2007)Annual rent (Due at beginning of year starting 5/1/07); $21,227.65BPO at EOL… $4,000.Lease term 5 yearsEconomic life- 10 yearsLessor’s cost.. $65,000FMV on 5/1/07… $91,000Lessors ROR… 10%Lessee’s ROR… 10%Lessee assumes all executory costs.collectibility reasonably predictable.no important uncertainties surrounding costsyet to be incurred by lessor.lessee assumes responsibility for all executory costsA. Discuss the NATURE of this lease to RODE (LESSEE).
28 The lease agreement has a BPO and, thus meets the criteria to be classified as a capital lease from the viewpoint of the lessee. The present value of theminimum lease payments exceeds 90% of the FMV of the assets.B. Discuss the nature of the lease to MOONEY Company (LESSOR).The lease agreement has a BPO. The collectibility of the lease paymentsis reasonably predictable, and there are no important uncertainties surroundingthe costs yet to be incurred by the lessor. The lease, therefore, qualifies as acapital type lease from the viewpoint of the lessor. Due to the fact that the initialamount of net investment (which in this case equal the present value of theminimum lease payments, $91,000) exceeds the lessor’s cost of $65,000, the leaseis a SALES TYPE LEASE.
29 C. Prepare Lease Amortization schedule for RODE (LESEE). Need the PV of the minimum lease payments.Should be $91,000 (FMV of asset).($21, x ) + ($4,000 x ) = $91,000rent10%, 5 yrsT 6-510%, 5 yrsT 6-2BPO
31 Prepare journal entries on the LESSEE’s books. Reversing entries ARE USED by RODES.Entries needed on 5/1/07Leased asset……….. $91,000Lease liability………$91,000Lease liability…. $21,227.65Cash……………$21,227.65
32 Entries needed on 12/31/07To record interestx 8/12 =Interest expense… $4,651.49Interest payable… $4,651.49To record depreciationDepreciation expense… $6,066.67Accumulated depreciation……. $6,066.67$91,000 / 10 = $9,100.00LIFE of assetbecause of BPO(no salvage is mentioned)$9,100 x 8/12 = $6,066.67
33 Entries on 1/1/08Interest payable……. $4,651.49Interest expense……. $4, REVERSINGEntries for 5/1/08Interest expense… $Lease Liability…. $14,250.41Cash…………….$21,227.65Entries for 12/31/08Interest expense…….. $ (5552 x 8/12)Interest payable……..$Depreciation Expense….. $9100Accumulated depreciation….$9100
34 Exercise 21-9 Lessor with BPO Continuation of E 21-8
35 A. Compute the amount of Lease Receivable at the start of the lease. ($21, x ) + ($4,000 x ) = $91,000
36 B. Prepare the lease amortization schedule for MOONEY AnnualLease Interest Net NetPayment (10%) on Investment InvestmentDate Plus BPO Investment Recovery5/1/ $91,0005/1/07 $21, $21, ,772.355/1/ , , , ,521.945/1/ , , , ,846.485/1/ , , , ,603.485/1/ , , , ,636.184/30/ , ,$110, $19, $91,000.00
37 D. Prepare journal entries for MOONEY. Reversing NOT used. Record the signing of the lease.Lease Receivable…. $91,000COG………………. $65,000Sales……. $91,000Inventory.. $65,000The first lease payment.Cash……. $21,227.65Lease Receivable…. $21,227.65
38 12/31/07 Adjust the interest.Interest Receivable....… $4,651.49Interest revenue……………..$4,651.49$6, x 8/12 = $4,651.495/1/08 Receipt of cash payment.Cash…….. $21,227.65Lease Receivable…… $14,250.41Interest Receivable.....$ 4,651.49Interest Revenue $ ($6, $4,651.49)Interest Receivable… $3,701.46Interest revenue………….$3,701.46Adjustment of interest 12/31/08$5, x 8/12 = $3,701.46
39 Rest of the entries for 20095/1/09 Cash…… $21,227.65Lease receivable…….$15,675.46Interest Receivable....$ 3,701.46Interest Revenue $ 1, (5, $3,701.46)12/31/09 Interest Receivable … $2,656.43Interest revenue…………$2,656.43* 8/12 adjustment (3, x 8/12 ) = $2,656.43
41 Morgan Marie Leasing Co. signs an agreement on January 1, 2004 to lease equipment to Cole William Company. The following information relates tothis agreement.1. The term of the noncancelable lease is 6 years with no renewal option.The equipment has an estimated economic life of 6 years.2. The cost of the asset to the lessor is $245,000. The fair value of theasset at January 1, 2004 is $245,000.3. The asset will revert to the lessor at the end of the lease term at whichtime the asset is expected to have a residual value of $43,622, noneof which is guaranteed.4. Cole William Company assumes direct responsibility for all executorycosts. (LESSEE RESPONSIBLE).5. The agreement requires equal annual rental payments, beginningon January 1, 2004.6. Collectibility of the lease payments is reasonably predictable. There areno important uncertainties surrounding the amount of costs yet to beincurred by the lessor.
42 $46,000 FMV = (Rent x factor) + (Residual value x factor) Instructions:a. Assuming the lessor desires a 10% rate of return on its investment,calculate the amount of the annual rent payment.FMV = (Rent x factor) + (Residual value x factor)$43,622.564476 10%$245,000$46,000
43 Morgan Marie Leasing Company (Lessor) Lease Amortization Schedule B. Prepare an amortization schedule that would be suitable for the lessorfor the lease term.Morgan Marie Leasing Company (Lessor)Lease Amortization ScheduleAnnualLease Interest Net BalanceDate Payment (10%) on Invest- of NetPlus URV Net Invest. ment Recovery Investment1/1/ $245,0001/1/ $46, $46, ,0001/1/ , , , ,9001/1/ , , , ,1901/1/ , , , ,6091/1/ , , , ,8701/1/ , , , ,65712/31/ , , ,$319, $ 74, $245,000
44 C. Prepare all of the journal entries for the LESSOR for 2004 and 2005. To record inception of lease 1/1/04Lease Receivable…………… $319,622Equipment……………………$245,000Unearned interest revenue… ,622To record receipt of first cash payment on 1/1/04Cash………………. $46,000Lease Receivable………… $46,000To record accrual of interest on 12/31/04Unearned interest revenue………. $19,900Interest revenue………………….$19,900
45 Receipt of second payment on 1/1/05 Cash…………….. $46,000Lease Receivable……….. $46,000Accrual of interest on 12/31/05Unearned interest revenue…… $17,290Interest revenue……………..$17,290