Question

Vendeur Ltd. owns a building in central Montreal. Vendeur enters into an agreement with Bailleur Inc., whereby Vendeur sells the building—but not the land on which it sits—to Bailleur and simultaneously leases it back. The details are as follows: ✓ The original cost of the building was $10,000,000; it is 60% depreciated on Vendeur’s books. ✓ Bailleur agrees to pay Vendeur $8,500,000 for the building, which is the fair value at the time of the sale. ✓ Bailleur agrees to lease the building to Vendeur for 20 years. The annual lease payment is $850,000, payable at the end of each lease year. ✓ There is no guaranteed residual value. ✓ Vendeur will pay all of the building’s operating and maintenance costs, including property taxes and insurance. ✓ The effective date of the agreement is 1 January 20X1. ✓ Vendeur’s incremental borrowing rate is 9%. ✓ Bailleur’s interest rate implicit in the lease is computed after tax and is not disclosed to Vendeur. ✓ Vendeur uses straight-line depreciation for its buildings, with full-year depreciation in the year of acquisition. ✓ Year-end of both companies is December 31 Required: 1. Prepare the journal entry to record the sale by Vendeur to Bailleur on January 1, 20X1.Record the journal entries required by Venduer to record the lease agreement including all the entries for the year 20X1 fiscal period including any entries required as a result of the sale leaseback.

Answer 1

	Calculating Present Value of Lease Payments
	Annual Lease Payment = $ 850000
	PV Annuity Factor @ 9% for 20 Years = 9.1285
	Present Value of Lease = $ 7759225 (=850000*9.1285)
	Sale is executed at Fair Value so no prepaid lease or Finance Provided
	If Sale is not executed at Fair Value then Diff. Shall be Prepaid lease or Additional Finance
	Carrying Amount of Building in books = $ 40,00,000 (60% Depreciated given) (A)
	Fair Value = $ 85,00,000 (B)
	Discounted Lease Payments = $ 77,59,225 ( C )
	ROU Asset (A/B*C)	$ 36,51,400.00	=(4000000/8500000)*7759225
	Seller Lessee recognises only the amount of rights that were transferred to buyer
	Gain (B-A)	$ 45,00,000.00
	Relating to Right to use building retained by Seller Lesse (Proportion to Discounted Lease Payments) =		$ 41,07,825.00
	Relating to Rights transferred to Buyer	$ 3,92,175.00
On Sale	Bank A/c                  Dr	$       85,00,000
	ROU Asset A/c        Dr	$       36,51,400
	To Building		$    40,00,000
	To Finance Lease Liability	$    77,59,225
	To Gain on sale		$       3,92,175
	Sale and Lease back accounted for
Year End
	Interest on Lease Liabililty A/c Dr	$       6,98,330
	To Finance Lease Liability		$       6,98,330
	Interest on Lease Liabililty accounted for
	Finance Lease Liability A/c       Dr	$       8,50,000
	To Bank			$       8,50,000
	Payment of liability
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