Question

Part One – January 1, 2017 Your client, Casandra Inc. has entered into an agreement to lease twenty railroad cars. The five-year lease agreement called for Casandra Inc., to make semi-annual lease payments of $120,000 payable each January 1, and July 1 with the first payment at the lease’s inception. At the end of the term, the property reverts back to the lessor. The estimated useful life of the property is six years. Casandra’s incremental rate is 10%. Casandra has knowledge that the lessor’s rate of return, used in determining the lease payments, was 8%. Casandra records depreciation on a straight-line basis at the end of each fiscal year. How do we account for this transaction? Part Two – One year later – January 1, 2018 Casandra is now considering subleasing the space to a third party. Today, Alexandra, Casandra’s controller, explained a proposal to sublease the underused railroad cars to, Apollo Inc. for the remaining four years of the lease term. Apollo would be substituted as lessee under the original lease agreement. As the new lessee, Apollo would become the primary obligor under the agreement and Cassandra would not be secondarily liable for fulfilling the obligations under the lease agreement. “Check on how we would need to account for this and get back to me,” she had said. Assume the effective date of the sublease would be July 1, 2018 Required: Prepare a memo to Alexandra, for each part, addressing the following: Part 1 – The accounting for the first year of the lease. Part 2 – Regarding the proposed sublease 1. Determine the appropriate accounting treatment for the proposed sublease. Address whether or not the proposal qualifies as a termination of a capital lease. 2. Include the determination of the balances in any lease related accounts today (one year after the start of the lease term). 3. What, if any, journal entry would Casandra record in connection with the sublease?

Answer 1

Lease option
Year-1
01/01/17	Lease Rental A/c Dr	$      120,000.00
	To Bank		$ 120,000.00
	(Being Lease rent first Insallment paid)
07/01/17	Lease Rental A/c Dr	$      120,000.00
	To Bank		$ 120,000.00
	(Being Lease rent Second Insallment paid)
Note: Lessee cannot claim depreciation on the leased out assets as he is not the owner of the assets and the assets will revert back to Owner as the end of Lease.
Sub-lease Option
Year-2
If Lease subleasing the space to a third party, i.e, Apollo for Four years the Cassandra will receive the Sub-lease amount from the Apollo company and pay the lease rent to the Lessor.
If Cassandra Internal rate of Return is 8% then sub-lease rental amount would be-
	Lease Rental for 4 years	$      960,000.00
	Incremental Rate@10%	$      265,224.00
	Total Sub-lease Amount	$ 1,225,224.00
	Sub-lease Amount Per month	$        25,525.50		306306
	1225224/48
The Sub-lease agreement would be beneficial for Cassandra as they has to pay 240000 Per year as lease payment but there are receiving $306306 ($25525.5X12) as sub-lease rentals
01/01/18	Lease Rental A/c Dr	$      120,000.00
	To Bank		$ 120,000.00
	(Being Lease rent Third Insallment paid)
01/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of Jan'18)
02/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of Feb'18)
03/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of Mar'18)
04/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of APr'18)
05/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of May'18)
06/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of June'18)
07/01/18	Bank A/c Dr	$        25,525.50
	To Sub-lease Income		$    25,525.50
	(Being Sub-lease income received for the month of July'18)
07/01/17	Lease Rental A/c Dr	$      120,000.00
	To Bank		$ 120,000.00
	(Being Lease rent Fourth Insallment paid)
Same Lease rental entry will be continue for the rest of 3 years
Same sub-lease rental entry will be continue for rest of sublease period.