Question

On January 1, 1996, Parkview Co. (lessee) signs a 10-year noncancelable lease agreement to lease a storage building from CONE Storage Company (lessor). The following information pertains to this lease agreement: The agreement requires equal rental payments of $78,314 beginning on December 31 1996. The annual payment includes S5,000 as reimbursement of property taxes. The fair value of the building on January 1, 1996 is $440,000. On CONE's book, it has a cost of $420,000. The building has an estimated useful life of 15 years. The estimated residual value at the end of the lease term of $80,000 is guaranteed by Parkview. Parkview Co. depreciates similar buildings on the straight-line method. The lease is nonrenewable. At the termination of the lease tem the building reverts back to the lessor. There is no uncertainty conceming rental and all other payments. Parkview's incremental borrowing rate is 15% per year. The lessor's implicit interest rate (known to Parkview) is 12%. . Required: Based on this information answer the following questions. Show all computations and round amounts to the nearest dollar. 1. What kind of lease is it for Parkview Co.? Why? 2. Prepare the journal entry Parkview Co. would make with respect to the lease on January 1, 1996. 3. Prepare all entries Parkview Co. would make with respect to the lease obligation and leased asset on December 31,1997 (note the year is 1997!!) What kind of lease is it for CONE? 4. 5. Write the journal entry CONE will make on 1/1/96. Write the journal entries CONE will make on 12/31/96 when it receives the first payment. 6.

Answer 1

Answer

Answer 1 Fair Value 440,000 NPV 440,000 100% Since present value of lease payments exceed 90% To be classified as Capital Lease for both Lessor& Lessee Lessee Books Workings: Year 10 10 Year for discountin 10 10 Salvage value is 73,314 73,314 Annual Lease Installments paid at the end of the year PV factor @ 12% 73,314 73,314 73,314 73,314 73,314 73,314 73,314 80,000 Guaranteed 73,314 0.71178 0.63 0.56743 0.89286 0.79719 0.50663 0.45235 0.40388 0.36061 0.3 0.32197 Present Value of Mn leae payments 610 26,438 23,605 65,459 41,601 58,445 52,184 46,593 37,143 33,164 25,758 440,000 Value at which to be recorded as asset by lessee is lower of 440,000 FMV or NPV Depreciation (FV-Salvage value)/10 years 6,000 36,000 36,00036,000 36,000 36,000 36,00036,000 36,00036,000 360,000

Amortization Schedule for Lessee Repayment Schedule Reduction Principal Outstandin Charges Payment Amount g Liability Finance Annual Year 440,000 52,800 73,314 20,514 419,486 50,338 73,31422,976396,510 47,581 73,314 25,733 370,776 44,49373314 28,821 341,95 73,31432,280309,675 73,314 36,153 273,522 73,314 40,492233,030 314 45,351 187,679 3,314 50,793136,887 41,035 37,161 32,823 27,964 22,522 16427153,314136,887 813,144 440,000 373143 1314 Lessee Books Debit General Journal Credit Jan 1, 1996 ) Capital Lease-in the books of Lessee Lease Equipment Lease Liability 440,000 440,000 To record the lease.) b) To record the depreciation Dec 31, 1996 Depreciation Expense 36,000 Accumulated Depreciation 36,000 Dec 31, 1996 c) To record interest Interest Expense 52,800 Lease Liabili 20,514 73,314 Dec 31, 1996 Executory Costs (Insurance and Taxes) Answer 3 Dec 31, 1997 Depreciation Expense Accumulated Depreciation 36,000 Dec 31, 1997 Interest Expense 50,338 Lease Liabilit 22,976 73,314 Dec 31, 1997 Executory Costs (Insurance and Taxes 5,000

Answer 4 Since present value of lease payments exceed 90% To be classified as Capital Lease for both Lessor & Lessee Answer 5 Lessor Books General Journal Debit Credit a. To record lease Jan 1, 1996 $440,000 Lease Recoverable Fair value is more than cost 420,000 Cost of Goods Sold Sales Revenue 440,000 Equipment Inventory 420,000 Answer 6 Dec 31, 1996 73,314 Cash Interest Receivable 52,800 Lease Recoverable 20,514