Question

Use the following data to about Johnson Company to answer question:

Johnson Company purchases an asset for $69,302 to lease to Carver, Inc. for four years with an annual lease payment of $20,000 at the end of each year. At the end of the lease, Carver will own the asset for no additional payment. The implied interest rate in the lease is 6%.

In 2007 Johnson Company had this financial statement data on its accounts:

Net income	$4,590
Depreciation	7,750
Taxes paid	5,322
Interest paid	1,500
Dividends paid	2,910
Cash received from sale of company building	3,455
Sale of preferred stock	4,355
Repurchase of common stock	3,000
Purchase of machinery	2,800
Issuance of bonds	5,000
Debt retired through issuance of common stock	4,500
Paid off long-term bank borrowings	9,000
Profit on sale of building	1,250

On January 1, 2008, Johnson Company acquires 80% of the common stock of Company S by paying $10,000 in cash to the shareholders of Company S. The pre-acquisition balance sheets are as follows:

Pre-acquisition B/S January 1, 2010	Johnson Company	Company S
Current assets	$58,000	$24,000
Other assets	22,000	11,000
Total	$80,000	$35,000
Current liabilities	$42,000	$21,000
Common stock	24,000	9,000
Retained earnings	14,000	5,000
Total	$80,000	$35,000

a)Determine how Johnson should account for the lease payments from Carver. Calculate the initial liability/asset reported on the balance sheet.

b)Prepare the amortization table for the lease and explain your answers.

c)Assuming US GAAP calculate CFO, CFF and CFI for Johnson company for year 2007. Please explain your calculations.

d)Prepare the post-acquisition balance sheet for Johnson Company using equity method. Please explain your answer (you are expected to prepare the balance sheet in the right format).

e)Prepare the post-acquisition balance sheet for Johnson Company using acquisition method. Please explain your answer (you are expected to prepare the balance sheet in the right format).

Answer 1

(a) Johnson company will treat the lease as Direct Financing lease because the carrying value or the book value of the asset purchased by the company is equal to the present value of lease payments of $69302 from Carver therefore Johnson company will show it as direct financing lease. For reporting purpose of the transaction, company will subtract the leased assets from non-current assets from the balance sheet and will make a separate heading by lease receivable amounting to $ 69302.

(b) Amortization table for the leased assets is shown in the below table

Year	Lease receivable in the beginning	Interest Income @ 6%	Lease Payments made	Lease Receivable in the end of the year
0				$69302
1	$69302	$4158	$20000	$53460
2	$53460	$3208	$20000	$36668
3	$36668	$2200	$20000	$18868
4	$18868	$1132	$20000	$0

As seen in the amortization table, Carver has not made any additional payments for owning the asset at the end of fourth year. They need to make constant payment of $20000 every year till 4 years. At the end of 4th year of lease, they will own the leased assets without making any additional payment.

(c) Calculation of CFO, CFI, CFF for Johnson 2007 year based on the given information in the question

Calculation of Cash Flow Statement from Operating Activities

Particulars	Amount
Net Income	4590
Add Depreciation	7750
Subtract Profit on sale of building	(1250)
Subtract Interest paid	(1500)
Subtract Tax Paid	(5322)
Net Cash flow from operating activities	4268

Calculation of Cash Flow Statement from Investing Activities ( based on information given)

Particulars	Amount
Cash received from sale of company building	3455
Subtract purchase of machinery	(2800)
Net Cash flow from investing activities	655

Calculation of Cash Flow Statement from Financing activities ( based on information given)

Particulars	Amount
Sale of preferred stock	4355
Add Issuance of bonds	5000
Subtract Dividend paid	(2910)
Subtract Repurchase of common stock	(3000)
Subtract paid too long term bank borrowings	(9000)
No change from debit retired through issuance of common stock (Not a cash transaction)	0
Cash used from financing activities	(5555)

Kindly Note* while preparing cash flow statement we will also consider interest income as an inflow from operating activities in the cash flow statements as interest income received from lease of asset will increase the overall earnings of the company.

(d) On January 1, 2008 Johnson acquired 80% of company S common stock through cash amounting to $10000. Journal Entry to record the transaction is written below

Date of transaction	Particulars	Debit Amount (Dr)	Credit Amount (Cr)
January 1 2008	Goodwill A/c Dr	17200
	To Common stock A/c Dr		7200
	To Cash Cr		10000
	(Being 80% of the company S common stock acquired through cash)

Post- acquisition Balance Sheet of Johnson company is given below

Particulars	Amount
Current Assets ($58000-10000)	$48000
Other Assets ( 22000+ 17200 Goodwill)	$39200
Total Assets	$87200
Currrent Liabilities	42000
Common Stock ( $24000 + $7200)	31200
Retained Earnings	14000
Total Liabilities + Shareholders Equity	$87200

While acquiring 80% of the common stock of company S through cash payment of $ 10000. Goodwill A/c will be debited for amount of $17200

Total Assets & Total (Liabilities + Shareholder's equity) of Johnson company post-acquisition will be $87200