Question

On January 1, 1996, ParkOne Co. (lessee) signs a 10-year noncancelable lease agreement to lease a storage building from DIY Storage Company (lessor). The following information pertains to this lease agreement:

• The agreement requires equal rental payments of $76,332 beginning on December 31, 1996. The annual payment includes $3,000 as reimbursement of property taxes.

• The fair value of the building on January 1, 1996 is $453,000. On DIY’s book, it has a cost of $400,000.

• The building has an estimated useful life of 15 years. The estimated residual value at the end of the lease term of $60,000 is guaranteed by ParkOne. ParkOne Co. depreciates similar buildings on the straight-line method.

• The lease is nonrenewable. At the termination of the lease term the building reverts back to the lessor. • There is no uncertainty concerning rental and all other payments.

• ParkOne’s incremental borrowing rate is 11% per year. The lessor’s implicit interest rate is 11%, too.

Required: Based on this information answer the following questions. Show all computations and round amounts to the nearest dollar.

1. What kind of lease is it for ParkOne Co.? Why?

2. Prepare the journal entry ParkOne Co. would make with respect to the lease on January 1, 1996.

3. Prepare all entries ParkOne Co. would make with respect to the lease obligation and leased asset on December 31, 1996.

4. What kind of lease is it for DIY Storage Co? 5. Write the journal entry DIY Storage Co. will make on 1/1/96. (Use the Net method.) 6. Write the journal entries DIY Storage Co. will make on 12/31/96 when it receives the first payment.

Answer 1

1. It is an Operating Lease because:

• Lease is Non-renewable
• At the termination of the lease term the building reverts back to the lessor
• Use full life of the assets is more than lease term.

2.

	Account Name	Debit	Credit
1-Jan	Right to Use Assets	453,000.00
	Lease Obligation		453,000.00
	(Lease recorded)

3.

	Account Name	Debit	Credit
31-Dec	Lease Expenses	79,332.00
	Right to Use Assets		29,502.00
	Lease Obligation		49,830.00
	(For Recording Lease Expenses)
31-Dec	Property Taxe Expesnes	3,000.00
	Cash		3,000.00
	(For Recording Property Tax paid)
31-Dec	Lease Obligation	79,332.00
	Cash		79,332.00
	(For Recording Lease Payment)

Total Lease Payment	793,320.00
Annual Expenses	79,332.00

Please note we can also pass a consolidated entry for above journal. I have given separate entries just for better understanding.

4. Sale Type Lease. Since Present Value of Lease rental exceeds the Carrying value.

	Account Name	Debit	Credit
1-Jan	Lease Receivable	453,000.00
	Leased Assets		453,000.00
	(Lease recorded)
31-Dec	Cash	73,332.00
	Lease Receivable		29,332.00
	Interest Income		44,000.00
	(For Recording Lease Expenses)
	(Recording of lease rental)
31-Dec	Cash	3,000.00
	Property Tax Payable		3,000.00
	(Reimbursement of Property tax by leasee)
31-Dec	Property Tax Payable	3,000.00
	Cash		3,000.00
	(Property tax Payment)

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