Question

In: Finance

Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make...

Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make lease payments over the next five years. The lease is cancelable and requires equal annual payments of $28,800 per year beginning on January 1 of the first year. The last payment will be January 1 of year 5, and Krawczek will continue to use the asset until December 31 of that year. Other important information includes the following:

  • The fair value of the equipment is $195,000.
  • The applicable discount rate is an 8 percent annual rate.
  • The economic life of the asset is 10 years.
  • Krawczek does not guarantee the residual value of the asset at the end of the lease, and it does not expect to keep the asset at the end of the term.
  • The asset is a standard piece of equipment.


a. Is the lease an operating lease or a financing lease?

  • Operating lease

  • Financing lease



b. What will be the lease expense shown on the income statement at the end of year 1?




c. What will be the interest expense shown on the income statement at the end of year 1? (Leave no cells blank – be certain to enter “0” wherever required.)


d. What will be the amortization expense shown on the income statement at the end of year 1? (Leave no cells blank – be certain to enter “0” wherever required.)

Solutions

Expert Solution

a. To be classified as an financing lease the following conditions needs to be met:

i. the lease term should cover atleast 75% of the total useful life of asset or

ii. the lessee should get an option to buy the asset at the end of lease term

iii. the asset should get transferred to the lessee after the completion of lease term

Since none of them applies to this particular scenario this is an Operating lease.

b. Since this is an Operating expense, the total lease expense will be the annual payments that needs to be made. So the lease expense for year 1 will be $28,800.

c. In case of Operating lease only the lease expense is shown on the income statement which includes the interest expense. Just like a rent expense is shown. So there will be no interest expense shown separately.

d. Since the Asset ownership is not going to be transferred to the lessee. There will be no amortization expense showed by him. However the lessor will be recording $19,500 as depreciation expense in his books.


Related Solutions

Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make...
Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make lease payments over the next five years. The lease is cancelable and requires equal annual payments of $32,000 per year beginning on January 1 of the first year. The last payment will be January 1 of year 5, and Krawczek will continue to use the asset until December 31 of that year. Other important information includes the following: The fair value of the equipment...
Jay Company, as lessee, enters into a lease agreement on January 1, 2020, to lease equipment....
Jay Company, as lessee, enters into a lease agreement on January 1, 2020, to lease equipment. The following data are relevant to the lease agreement. - The term of the noncancellable lease is three years, with no renewal option. Payments of $12,000 are due on January 1, of each year. - The fair value of the equipment on January 1, 2020 is $35,000. The equipment has an estimated economic life of five years, and an unguarenteed residual value of $4,000....
Jay Company, as lessee, enters into a lease agreement on January 1, 2020, to lease equipment....
Jay Company, as lessee, enters into a lease agreement on January 1, 2020, to lease equipment. The following data are relevant to the lease agreement. - The term of the noncancellable lease is three years, with no renewal option. Payments of $12,000 are due on January 1, of each year. - The fair value of the equipment on January 1, 2020 is $35,000. The equipment has an estimated economic life of five years, and an unguarenteed residual value of $4,000....
Marin Leasing Company signs a lease agreement on January 1, 2020, to lease electronic equipment to...
Marin Leasing Company signs a lease agreement on January 1, 2020, to lease electronic equipment to Cullumber Company. The term of the non-cancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Cullumber has the option to purchase the equipment for $21,500 upon termination of the lease. It is not reasonably certain that Cullumber will exercise this option. 2. The equipment has a cost of $230,000 and...
Western Company leased equipment from Sunshine Industries. The lease agreement qualifies as a finance lease and...
Western Company leased equipment from Sunshine Industries. The lease agreement qualifies as a finance lease and requires annual lease payments of $120,000 over a five-year lease term (also the asset’s useful life), with the first payment at January 1, 2018, the beginning of the lease. The interest rate is 9%. The asset being leased cost Sunshine $500,000 to produce. The total increase in earnings (pretax) on Sunshine’s December 31, 2018, income statement would be: a. $0 b. $35,534 c. $43,755...
Larkspur Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to...
Larkspur Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Crane Company. The term of the non-cancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Crane has the option to purchase the equipment for $15,500 upon termination of the lease. It is not reasonably certain that Crane will exercise this option. 2. The equipment has a cost of $110,000 and...
Castle Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to...
Castle Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Jan Way Company. The term of the non-cancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Jan Way has the option to purchase the equipment for $16,000 upon termination of the lease. It is not reasonably certain that Jan Way will exercise this option. 2. The equipment has a cost...
Bonita Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to...
Bonita Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Windsor Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Windsor Company has the option to purchase the equipment for $17,100 upon termination of the lease. 2. The equipment has a cost and fair value of $166,000 to Bonita Leasing Company. The useful economic life...
Sandhill Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to...
Sandhill Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Teal Company. The term of the noncancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Teal Company has the option to purchase the equipment for $17,000 upon termination of the lease. 2. The equipment has a cost and fair value of $176,000 to Sandhill Leasing Company. The useful economic life...
Fireval Machine Works Co. signs an agreement on Jan 1, 2018, to lease equipment to Reid...
Fireval Machine Works Co. signs an agreement on Jan 1, 2018, to lease equipment to Reid company. the following information relates to the agreement: >The term of the noncancable lease is 5 years with no renewal option. The equipment has an estimated economic life of 6 years >the agrrement requires equal semi-annual payments, beginning on Jan 1, 2018. >The cost of the asset of the lessor is 350,000. The fair value of the asset at Jan 1, 2018 is 450,000....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT