Question

Epps Corp., a public company, leased equipment from Anderson Inc. on January 2, 2018, for a period of three years. Lease payments of $100,000 are due to Anderson Inc. each year on December 31. The lease contains no purchase or renewal options and the equipment reverts back to Anderson Inc. on the expiration of the lease. The remaining useful life of the equipment is four years (the equipment is new at the time Epps leases it). The fair value of the equipment at lease inception is $270,000. Epps Corp. has guaranteed $20,000 as the residual value at the end of the lease term. The $20,000 represents the expected value of the leased equipment to the lessee at the end of the lease term. The salvage value of the equipment is expected to be $2,000 after the end of its economic life. Epps’ incremental borrowing rate is 9 percent. Anderson’s implicit rate is 10 percent and is known by Epps.

The assistant controller  and controller of Epps Corp. analyzed the lease and made their recommendations for the appropriate accounting.. As the CFO, you were given both analyses to determine the correct accounting treatment. Calculations and journal entries performed by the assistant controller and controller are below.

Assistant controller analysis:

Since the equipment reverts back to Anderson Inc., Epps should not record an asset or liability on the lease.

Entries to be posted in Years 1, 2, and 3:

Dr. Lease expense                           $100,000

Cr. Cash                                                        $100,000

Controller analysis:

The lease term is for three years. Since it is long-term, an asset and liability must be recorded. The amount of the asset and liability is based on the present value of the lease payments. The controller uses Epps’ incremental borrowing rate since it is the lower rate.

Present value of the lease payments = $100,000 × 2.53129 = $253,129

Since interest has to be charged on the straight-line method, the controller determines the following for the amortization of the lease liability.

                                                                                                Reduction in             Balance of

                                                                 Interest                     Lease                         Lease

  Year             Cash Payment             Expense                  Obligation               Obligation

    0                                                                                                                              $253,129

    1                  $100,000                        $15,624                $84,376                     $168,753

    2                  $100,000                        $15,624                $84,376                     $  84,377

   3                  $100,000                        $15,623                $84,377                     $           0

Journal entries in Year 1:

January 2

Leased Asset                                   253,129

            Lease Obligation                                                    253,129

December 31

Interest expense                             15,624

Lease obligation                             84,376

Cash                                                              100,000

Depreciation Expense                     84,376

             Accumulated Depreciation                          84,376        

Required:

1. Was the assistant controller’s analysis correct? Why or why not?

2. Was the controller’s analysis correct? Why or why not?

3. If neither answer is correct, show the correct analysis including all year one entry(ies).

Be sure to provide appropriate authoritative sources for positions taken.

Answer 1

Answer: Given,

leaswe payment=$100000

fair value of the equipment =$270000

THANK YOU!