Question

Amsterdam Leasing Company agrees to lease machinery to Harrisburg Corporation on January 1, 2019. The following information relates to the lease agreement. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. The asset is not of a specialized nature. The machinery cost is $525,000 and the fair value of the asset on January 1, 2019 is $700,000. At the end of the lease term, the asset reverts to lessor and has a guaranteed residual value of $50,000 and Harrisburg estimates the expected residual value at the end of the lease term will be $50,000. Harrisburg amortizes all of its leased equipment on the straight-line basis. The lease agreement requires equal of $109,365, beginning on January 1, 2019. The lessor believes the collectability of the lease payments is probable. Amsterdam desires a rate of return of 5% on its investments. Harrisburg’s incremental borrowing rate is 6%, and the lessor’s incremental implicit rate is unknown.

Instructions:

1. Using the lease classification tests, determine the nature of this lease for the lessee.

2. Compute the value of the lease liability to the lessee.

3. Prepare the journal entries for Harrisburg for 2019 and 2020 related to the lease arrangements.

4. Suppose Harrisburg estimates the residual value at the end of the lease term to be $40,000, but still guarantees a residual of $50,000. Compute the value of the lease liability at lease commencement.

Round all numbers to the nearest dollar. You must show supporting computations to receive credit

Answer 1

	Lessee Accounting: Harrisburg Corporation
1	At present, the nature of lease exists for the Lessor only and the Leasee is required to use a single accounting model for every type of lease. The present value of lease payment & residual value discounted @5% is equal to to the fair value of asset i.e. $7,00,000 and accordingly its a Finance lease for the lessor.
2	The lease liability and the ROU asset are measured on the commencement date using the Implicit rate of interest or incremental borrowing rate(i.e.,6% p.a. in this case)(if implicit rate is not known) at lease commencement date . The lease liability is accounted for by the interest method subsequently and the ROU asset is subject depreciation on the straight-line basis over the lease term of 7 year.
	The leasee shall record the lease liability (Present value of Lease payment & expected residual value, if guaranteed ) & right in use asset in the given case.
	Year	Payments (Cash flows)	Present Value Facr @6%p.a.	Discounted Cash flows/ Present value
	1	$                        109,365.00	1	$               109,365
	2	$                        109,365.00	0.94340	$               103,175
	3	$                        109,365.00	0.89000	$                  97,334
	4	$                        109,365.00	0.83962	$                  91,825
	5	$                        109,365.00	0.79209	$                  86,627
	6	$                        109,365.00	0.74726	$                  81,724
	7	$                        109,365.00	0.70496	$                  77,098
	7	$                          50,000.00	0.70496	$                  35,248
	Total	$                              815,555		682,396
	Lease Amortisation Schedule:
Year	Opening lease liability	Lease Payments	Interest Expense @ 8% per annum	Closing lease liability
	a	b	c=(a-b)*10%	d=a+c-b
2019	$        682,396	$                              109,365	$                     34,382	$               607,413
2020	$        607,413	$                              109,365	$                     29,883	$               527,931
	Note: As the lease payment is made at the beginning of the month, interest will be calculated on Opening lease liability less lease payment .
	Right in use asset Schedule: (Amortisation=$682,396/7 year= $97,485)
	Year	Opening	Depreciation	Closing
	2019	$                              682,396	$                     97,485	$               584,911
	2020	$                              584,911	$                     97,485	$               487,426
		In the books of Leasee
3		Journal Entries
	Year	Particulars	Debit	Credit
	01-01-19	Right of Use Asset	$                  682,396
		Lease liabilty		$               682,396
		(To record initially recognise the lease-related asset and liability .)
	01-01-19	Lease liabilty	$                  109,365
		Cash		$               109,365
		( To record lease payment)
	31-12-19	Interest expense	$                     34,382
		Lease liabilty		$                  34,382
		(To record interest expense & lease liablity paid)
		($6,82,396-$109,365)*6%
	31-12-19	Amortisation expense	$                     97,485
		Right of Use Asset		$                  97,485
		( To record depreciation expense on the ROU asset)
		($6,82,396/7 years)
	01-01-20	Lease liabilty	$                  109,365
		Cash		$               109,365
		( record lease payment)
	31-12-20	Interest expense	$                     29,883
		Lease liabilty		$                  29,883
		(To record interest expense & lease liablity paid)
		($6,82,396-$109,365+34,382-109365)*6%
	31-12-20	Amortisation expense	$                     97,485
		Right of Use Asset		$                  97,485
		(To record depreciation expense on the ROU asset)
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