Question
In: Accounting
On January 1, 2019 the Halle Brothers, an Agricultural Irrigation Equipment dealer, leased to Vic Werloff...
On January 1, 2019 the Halle Brothers, an Agricultural Irrigation Equipment dealer, leased to Vic Werloff Farming, a Peerless Turbine Hi Volume Irrigation Pump.
The term of the lease is 6 years with no renewal option, and because the turbine pump has an economic life of 6 years, it is estimated to have a zero residual value and will revert back to Halle Brothers at the conclusion of the lease.
The fair value of the turbine pump is $210,000 and cost Halle Brothers $130,000.
Halle Brothers set the annual lease payment to provide a 12% return.
The lease requires annual payments of $45,604.78 due at the beginning of each year, with the first payment due at the signing of the lease.
Vic Werloff’s incremental borrowing rate is 12%.
Vic Werloff depreciates all of its equipment on a straight line basis.
Required:
Prepare all necessary journal entries for 2019 and 2020 for both Halle Brothers and Vic Werloff.
Hint:
For Halle Brothers (the Lessee), the lease on their books is to be accounted for as a “Sales Type Lease”.
For Vic Werloff (the Lessor), the lease on their books is to be accounted for as a “Capital” lease.
Halle Brothers and Vic Werloff both have a December 31st yearend.
Remember:
Depreciation expense needs to be reported on the Vic Werlloff’s books.
A gain on sale needs to be reported on the Halle Brothers’ books.
Solutions
Expert Solution
| Lessee Accounting: | ||||
| The leasee should use a single accounting model for all type of lease. The lease liability and the ROU asset are measured on the commencement date using the Implicit rate of interest (i.e.,12% p.a. in this case)or incremental borrowing rate(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 6 year. | ||||
| The leasee shall record the lease liability and right in use asset at the Present value of Lease payment & expected residual value as the same is guaranteed as calculated below. | ||||
| Year | Payments (Cash flows) | Present Value Factor @12%p.a. | Discounted Cash flows/ Present value | |
| 1 | $ 45,604.78 | 1 | $ 45,604.78 | |
| 2 | $ 45,604.78 | 0.89286 | $ 40,718.55 | |
| 3 | $ 45,604.78 | 0.79719 | $ 36,355.85 | |
| 4 | $ 45,604.78 | 0.71178 | $ 32,460.58 | |
| 5 | $ 45,604.78 | 0.63552 | $ 28,982.66 | |
| 6 | $ 45,604.78 | 0.56743 | $ 25,877.38 | |
| Total | $ 273,629 | $ 209,999.81 | ||
| c | Lease Amortisation Schedule: | |||
| Beg of year |
Annual Lease Payments Plus expected residual value |
Interest on lease liability | Reduction of lease Liability | Lease liability |
| 0 | $ - | $ - | $ - | $ 209,999.81 |
| 1 | $ 45,604.78 | $ - | $ 45,604.78 | $ 164,395.03 |
| 2 | $ 45,604.78 | $ 19,727.40 | $ 25,877.38 | $ 138,517.65 |
| 3 | $ 45,604.78 | $ 16,622.12 | $ 28,982.66 | $ 109,534.99 |
| 4 | $ 45,604.78 | $ 13,144.20 | $ 32,460.58 | $ 77,074.40 |
| 5 | $ 45,604.78 | $ 9,248.93 | $ 36,355.85 | $ 40,718.55 |
| 6 | $ 45,604.78 | $ 4,886.23 | $ 40,718.55 | $ (0.00) |
| Note: As the lease payment is made at the beginning of the year, interest will be calculated on Opening lease liability less lease payment . | ||||
| In the books of Leasee | ||||
| a | Journal Entries | |||
| Year | Particulars | Debit | Credit | |
| 01-01-19 | Right of Use Asset | $ 209,999.81 | ||
| Lease liabilty | $ 209,999.81 | |||
| (To record initially recognise the lease-related asset and liability .) | ||||
| 01-01-19 | Lease liabilty | $ 45,604.78 | ||
| Cash | $ 45,604.78 | |||
| (To record lease payment) | ||||
| 31-12-19 | Interest expense | $ 19,727.40 | ||
| Lease liabilty | $ 19,727.40 | |||
| (To record interest expense) | ||||
| 31-12-19 | Depreciation expense | $ 34,999.97 | ||
| Right of Use Asset | $ 34,999.97 | |||
| ( To record depreciation expense on the ROU asset) | ||||
| 01-01-20 | Lease liabilty | $ 45,605 | ||
| Cash | $ 45,605 | |||
| (To record 2nd lease payment) | ||||
| In the books of Lessor | ||||
| Journal Entries for Sale type lease | ||||
| Date | Particulars | Debit | Credit | |
| 01-01-19 | Lease Receivable | $ 209,999.81 | ||
| Cost of Machine | $ 130,000.00 | |||
| Gain on sale of Equipment | $ 79,999.81 | |||
| (To record asset given on lease under sale type lease ) | ||||
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