Question

LEASE ONE In January 2019, Alsace Company leased equipment with a fair value of $2,500,000 from Lorraine Corp. Lorraine estimates that the residual value of the equipment at the end of the lease term will be $750,000. Alsace is required to apply ASC 842 when accounting for the lease.

The leasing contract includes the following terms:

I. Alsace will make 10 end-of-year payments of $300,000 each beginning on December 31, 2019.

II. Alsace will have complete control of the equipment until it is returned to Lorraine on January 1, 2029.

Required:

1. Calculate the following (using EXCEL):

A. The implicit interest rate.

B The present value of the lease payments.

2. Complete each of the four following lease clauses any of which, if included in the lease contract, would require treating the lease as a finance lease:

a. ______________ is transferred to Alsace at the end of the lease term.

b. Alsace may ______________ the equipment for $200,000.

c. The _________________________ of the equipment is 12 years.

d. The equipment was ___________________ for Alsace.

LEASE TWO In January 2019, Alsace Company leased equipment with a fair value of $2,500,000 from Lorraine Corp. Lorraine estimates that the residual value of the equipment at the end of the lease term will be $750,000. The lease has a useful life of fifteen years. Alsace is required to apply ASC 842 when accounting for the lease.

The leasing contract includes the following terms:

I. Alsace will make 10 end-of-year payments of $300,000 each beginning on December 31, 2019.

II. Alsace will have complete control of the equipment until it is returned to Lorraine on January 1, 2029.

III. Alsace guarantees $400,000 of residual value on January 1, 2029.

Required:

1. Calculate (using EXCEL) the present value of the lease payments.

2. Present appropriate journal entries to be made by Alsace:

a. at the commencement of the lease on January 1, 2019.

b. when the initial lease payment is made on December 31, 2019.

Answer 1

As Per Asc 842 when implicit rate not specifically given in question and fair value leased equipment given in question then we use trail and error method to calculate the discount rate at which Pv of lease payment and residual value equal to Fair value of asset .

Lease 1-

How to calculate implicit implicit intrest rate -Using trail and error method

Assume Discount rate - 7 %

YEAR- 1- 10 pv value of lease paymet - $300000 *7.023 = $21,06,900

YEAR - 10- Salvage value - $7,50,000 * 0.508    = $3,81,262

Total    = $24,88,162

Assume Discount rate - 6 %

YEAR- 1- 10 pv value of lease paymet - $300000 *7.36 = $22,08,000

YEAR - 10- Salvage value - $7,50,000 * 0.508    = $4,18,500

Total    = $26,26,500

Formula - Trail & Error Method

= Lower rate + Cash Flow at Lower rate - Fair value/Cash flow at lower rate - cash flow at higher rate

= 6% + 26,26,500-25,00,000/26,26,500-24,88,162

= 6.914%

So the implicit rate is 6.914%

2- Calculation of present value of lease payment -

So here implicit rate is not given hence Pv of lease payemt will be equal to Fair value of equipement

3- Lease Clauses -To be considered as Fiancial lease

1- Ownwrship

2-Purchase

3-Life

4-Specialized in nature

Lease 2-

1. As again pv value of lease payment is equal to fair value $ 25,00,000 as implicit rate are missing in question

2- Jornal entry -Lease is Finance lease

At Commencement of lease - 1 jan 2019

Dr Right to use Asset - $25,00,000

Cr Lease Liability - $25,00,000

Lease Payment- 31 dec 2019

Dr Lease Liability - $3,00,000

Cr Cash - $3,00,000