Question

Accounting for lessee finance lease including executory costs and residual value guarantee under ASU 2016-02 (ASC 842). On January 1, 2017, Bares Trees Company signed a three-year noncancelable lease with Dreams Inc. The lease calls for three payments of $62,258.09 to be made at each year-end. The lease payments include $3,000 of executory costs related to service. The lease is nonrenewable and has no bargain purchase option. Ownership of the leased asset reverts to Dreams at the end of the lease period, at which time Bare Trees has guaranteed that the leased asset will be worth at least $15,000. The leased asset has an expected useful life of four years, and Bares Trees uses straight-line depreciation for financial reporting purposes. Bares Trees' incremental borrowing rate is 9%. Bare Trees and Dreams account for leases under ASC 842. Required: 1. Prepare Bare Trees Company's amortization schedule for the lease liability. Round the amount of the intial lease liability at January 1, 2017, to the nearest dollar. Round all amounts in the amortization table to the nearest cent. 2. Prepare Bare Trees Company's journal entries to record (a) the lease on January 1, 2017; (b) the lease payments on December 31, 2017 and 2018; and (c) the leased asset's depreciation on 2017 and 2018. 3. Assume that at the end of the lease term, the leased asset will be worth $16,000. Make Bare Trees Company's journal entry to account for the residual value guarantee. 4. Repeat requirement 3, but assume that the leased asset will be worth $12,000 at the end of the lease term.

Answer 1

1. Prepare Bare Trees Company's amortization schedule for the lease liability. Round the amount of the intial lease liability at January 1, 2017, to the nearest dollar. Round all amounts in the amortization table to the nearest cent.

Present value of future lease payments is:

(Annual lease payments - Executory costs x present value of ordinary annuity at 9% for 3 years) + (Residual guarantee value x present value of $1 at 9% for 3 years)

= [($62,258.09-$3,000) x (1-(1+rate of return)^-no. of periods) / rate of return] + ($15,000 x 1/ (1+rate of return)^no. of periods)

= $59,258.09 x (1-(1+0.09)^-3)/0.09) + $15,000 x 1/(1+0.09)^3

= $59,258.09 x 2.53130 + $15,000 x 0.77218

= $161,583.

Amortization schedule for lease liability:

2. Bare Trees Company's journal entries to record

(a) the lease on January 1, 2017:

Capital lease asset A/c Debit $161,583

To Capital lease liability A/c Credit $161,583

(b) the lease payments on December 31, 2017 and 2018:

December 31, 2017:

Capital lease liability A/c Debit $44,715.62 ($59,258.09-$14,542.47)

Interest expense A/c Debit $14,542.47

Lease executory costs A/c Debit $3,000

To Cash/ Bank A/c Credit $62,258.09

December 31, 2018:

Capital lease liability A/c Debit $48,740.03 ($59,258.09-$10,518.06)

Interest expense A/c Debit $10,518.06

Lease executory costs A/c Debit $3,000

To Cash/ Bank A/c Credit   $62,258.09

(c) the leased asset's depreciation on 2017 and 2018:

Depreciation expense = (Asset cost - Residual value)/ Useful life of asset

Depreciation = ($161,583-$15,000)/ 3 = $48,861

Depreciation expense A/c Debit $48,861

To Accumulated depreciation on leased assets A/c Credit $48,861

3. Assume that at the end of the lease term, the leased asset will be worth $16,000. Make Bare Trees Company's journal entry to account for the residual value guarantee.

Capital lease liability A/c Debit $15,000

To Capital lease asset A/c Credit $15,000

4. Repeat requirement 3, but assume that the leased asset will be worth $12,000 at the end of the lease term.

Capital lease liability A/c Debit $15,000

Loss on residual value guarantee A/c Debit $3,000

To Capital lease asset A/c Credit $15,000

To Cash/Bank A/c Credit $3,000