Question

On January 1, 2018, Morris Company sells land to Lopez Corporation for $10,000,000, and immediately leases the land back. The following information relates to this transaction:

1.   The term of the noncancelable lease is 20 years and the title transfers to Morris Company at the end of the lease term.

2.   The land has a cost basis of $8,400,000 to Morris.

3.   The lease agreement calls for equal rental payments of $943,074 at the beginning of each year.

4.   The land has a fair value of $10,000,000 on January 1, 2018.

5.   The incremental borrowing rate of Morris Company is 10%. Morris is aware that Lopez Corporation set the annual rentals to ensure a rate of return of 8%.

6.   Morris Company pays all executory costs which total $255,000 in 2018.

7.   Collectibility of the rentals is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(a)    Prepare the journal entries for the entire year 2018 on the books of Morris Company to reflect the above sale and lease transactions (include a partial amortization schedule and round all amounts to the nearest dollar.)

(b)    Prepare the journal entries for the entire year 2018 on the books of Lopez Corporation to reflect the above purchase and lease transactions.

Answer 1

Answer :-

a) The journal entries for the entire year 2018 on the books of Morris Company to reflect the sale and lease transactions are as follows :-

Date	Account Titles and Explanation	Debit	Credit
Jan 1, 2018	Cash	$10,000,000
	To Land		$8,400,000
	To Unearned Profit an Sale - Leaseback		$1,600,000
	(To record the sale)
Jan 1, 2018	Leased Land	$10,000,000
	To Lease liability		$9,056,926
	To Cash		$943,074
	(To record the lease )
In 2018	Executory Costs	$255,000
	To Accounts Payable and Cash		$255,000
	(To record executory costs )
Dec 31, 2018	Unearned Profit an Sale-Leaseback	$80,000
	To Revenue from sale ($1,600,000 / 20 years lease term)		$80,000
	(To record amortization of profit on sale)
Dec 31, 2018	Interest Expense	$724,554
	To Interest Payable ($9,056,926 × 8% rate of return)		$724,554
	(To record Interest Expense)

Partial Amortization Expense are -

Date	Annual lease payment	Interest Expense (8%)	Reduction of lease liability	Remaining balance
Jan 1, 2018				$10,000,000
Jan 1,2018	$943,074	$0	$943,074	$9,056,926
Jan 1,2019	$943,074	$724,554	$218,520	$8,838,406

b)The journal entries for the entire year 2018 on the books of Lopez Corporation to reflect the above purchase and lease transactions are as follows :-

Date	Account Titles and Explanation	Debit	Credit
Jan 1,2018	Land	$10,000,000
	To Cash		$10,000,000
	(To record the Purchase)
Jan 1, 2018	Cash	$943,074
	Lease receivable	$9,056,926
	To Land		$10,000,000
	(To record the leaseback)
Dec 31,2018	Interest Receivable	$724,554
	To Interest Revenue		$724,554
	(To record the interest revenue)