Question

Assume that on December 31, 2019, Kimberly-Clark Corp. signs a 10-year, non-cancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement.

1.		The agreement requires equal rental payments of $66,899 beginning on December 31, 2019.
2.		The fair value of the building on December 31, 2019 is $488,978.
3.		The building has an estimated economic life of 12 years, a guaranteed residual value of $9,000, and an expected residual value of $6,200. Kimberly-Clark depreciates similar buildings on the straight-line method.
4.		The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor.
5.		Kimberly-Clark’s incremental borrowing rate is 8% per year. The lessor’s implicit rate is not known by Kimberly-Clark.

1.Suppose the same facts as above, except that Kimberly-Clark incurred legal fees resulting from the execution of the lease of $5,000, and received a lease incentive from Sheffield to enter the lease of $1,000. How would the initial measurement of the lease liability and right-of-use asset be affected under this situation?

Right-of-use asset $

2.

Suppose that in addition to the $66,899 annual rental payments, Kimberly-Clark is also required to pay $5,000 for insurance costs each year on the building directly to the lessor, Sheffield Storage. How would this executory cost affect the initial measurement of the lease liability and right-of-use asset? (Round answer to 0 decimal places)

Lease liability $ 3. Now suppose that, at the end of the lease term, Kimberly-Clark took good care of the asset and Sheffield agrees that the fair value of the asset is actually $9,000. Record the entry for Kimberly-Clark at the end of the lease to return control of the storage building to Sheffield (assuming the accrual of interest on the lease liability has already been made). (Credit account titles are automatically indented when the amount is entered. Do not indent manually.

Answer 1

All amounts are in $

Annual lease payment = 66,899

Guaranteed residual value = 9,000

Present value of minimum lease payments

= 66,899 x (1 + PVIFA(8%, 9 years)) + (9,000-6,200) x PVIF(8%, 9th year)

= 66,899 x (1+6.24689) + (9,000-6,200) x (0.46319)

= 484,810 + 1,297

= 486,107 (amounts may vary slightly due to rounding off)

(1)

The initial direct costs and any incentives will not affect the lease liability amount but this will affect the asset account (Rightom of Use of asset Finance lease)

So lease liability = 486,107

Right of use Finance leased asset = 486,107 - 1,000 + 5,000

= 490,107

(Direct cost increase the asset value and incentives decrease the asset value)

(2)

The Insurance payments are made to lessor along with the annual lease payments and these alo form part of lease payments. So this value should be added to get get the New lease liability and New Right of Use of asset Finance liability

Old Present value of lease payments = 486,107

Add : Present value of insurance = 36,234 (5,000 x (1+PVIFA(8%, 9 years)

(Here insurance is also taken as year starting payment)

Total Value = 522,341

This will be the new balance of lease liability and leased asset

(3)

If the residual value is $9,000

But in books lease liability will be shown at $2,800 ($9,000-$6,200)

This is now not necessary to be paid to lessor as the actual residual value is equal to guaranteed residual value.

So now we will transfer this amount to Income statement

Journal entry

Lease liability $2,800

Gain on Lease $2,800

(The liability amount which is not required to be paid is now transferred to Gain and then the Income statement)