Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $25,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $180,000 (its fair value) and was expected to have a useful life of 13 years with no salvage value at the end of its life. (Because the lease term is only nine years, the asset does have an expected residual value at the end of the lease term of $50,995.) Crescent seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be an operating lease.

Required:

1. What will be the effects of the lease on Crescent’s (lessor’s) earnings for the first year (ignore taxes)?

2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Crescent (ignore taxes)?

Answer 1

ANSWER:

Requirement 1

Income Statement:

Lease revenue (straight-line amount)......................... $25,000

Depreciation ($180,000 ÷13 years)................................... (13,846)

Increase in earnings (pretax).......................... $11,154

In anoperating lease, the lessorrecords lease revenue on a straight-line basis. The lessor, having recorded no entry affecting its balance sheet at the beginning of the lease, simply records lease payments as lease revenue on a straight-line basis and records depreciation on the asset it doesn’t remove from its records.

Requirement 2

Assets:

Restaurant equipment (cost)................................. $180,000

Accumulated depreciation ($180,000 ÷13 years).....    (13,846)

Equipment balance (net)   $166,154

Liabilities:

Deferred lease revenue........................................ $25,000

In anoperating lease, the lessorrecords lease revenue on a straight-line basis. The lessor, having recorded no entry affecting its balance sheet at the beginning of the lease, simply records lease payments as lease revenue on a straight-line basis and records depreciation on the asset it doesn’t remove from its records.