Question

In: Accounting

Bullwinkle Corp. leased medical equipment from Rocky Co., signing a lease agreement that stipulates annual payments...

Bullwinkle Corp. leased medical equipment from Rocky Co., signing a lease agreement that stipulates annual payments of $250,000 on January 1 of each year for a five-year period. The first payment is due at the signing of the lease transaction on 1/1/17.

Rocky Co. set an implicit rate of 6% in the terms of the agreement, which is equal to the incremental borrowing rate of Bullwinkle Corp. Rocky has also stipulated a residual value of $400,000 at the end of the lease term. Bullwinkle is not required to guarantee it.

There is no transfer or ownership and the lease is noncancellable. The fair value of the leased equipment is $1,415,180 and the equipment cost Rocky Co. $800,000 to manufacture. It has a useful life of 10 years.

Classify the lease and provide evidence to substantiate your classification decision.

1. Provide journal entries for both lessee and lessor at the inception of the lease (1/1/17).

2. Provide journal entries to record the necessary adjustments at year-end, 12/31/17.

3. Provide journal entries to record the payment of cash on 1/1/17.

4. Provide new journal entries adjusting the lease contract on 12/31/17 if the $400,000 guaranteed residual value were set to $1,000,000 (assume all other information regarding the lease contract remains constant).

Solutions

Expert Solution

The lease will be classified as Operating Lease:

  1. The useful life of the assets is more than lease term
  2. No Buyback option at the end of the lease term
  3. No Ownership Transfer

Part1:

In the Books of Lessee
Date Account description Debit Credit
1-Jan Right to Use Assets      1,116,276
Lease Obligation          866,276
Cash          250,000
(Being Lease Recorded)
In the Books of Lesser
Date Account description Debit Credit
1-Jan Lease Receivable          866,276
Cash          250,000
Residual Assets          298,903
Lease Assets          800,000
Deferred Gross Profit          615,180
(Being Lease Recorded)

Workings:

Present Value of Lease Cashflow
Cashflow PV Factor Present Value
0          250,000 1              250,000
1          250,000 0.943396              235,849
2          250,000 0.889996              222,499
3          250,000 0.839619              209,905
4          250,000 0.792094              198,023
5 0.747258                         -  
         1,116,276

Part 2:

In the Books of Lessee
Date Account description Debit Credit
31-Dec Lease Expenses          250,000
Right to Use Assets          198,023
Lease Obligation            51,977
(Being Lease Expenses Recognised)
In the Books of Lesser
Date Account description Debit Credit
31-Dec Lease Receivable            51,977
Residual Assets            17,934
Deferred Gross Profit            10,089
Interest Income            80,000
(Being Lease Revenue Recognised)

Workings:

Amortization Table
Lease Expenses Interest Lease Obligation Amortization
0                     250,000          866,276
1                     250,000          51,977          668,253            198,023
2                     250,000          40,095          458,348            209,905
3                     250,000          27,501          235,849            222,499
4                     250,000          14,151                    (0)            235,849
5                                -                    (0)                    (0)            250,000

Part 3:

In the Books of Lessee
Date Account description Debit Credit
1-Jan Lease Obligation          250,000
Cash          250,000
(Being Lease Rental Paid)
In the Books of Lesser
Date Account description Debit Credit
1-Jan Cash          250,000
Lease Receivable          250,000

Part 4:

In the Books of Lessee
Date Account description Debit Credit
31-Dec Right to Use Assets          747,258
Lease Obligation          747,258
31-Dec Lease Expenses          250,000
Right to Use Assets          153,188
Lease Obligation            96,812
In the Books of Lesser
Date Account description Debit Credit
1-Jan Lease Receivable          747,258
Deferred Gross Profit          448,355
Residual Assets          298,903
31-Jan Lease Receivable            96,812
Deferred Gross Profit            16,812
Interest Income            80,000

Workings:

Present Value of Lease Cashflow
Cashflow PV Factor Present Value
0          250,000 1              250,000
1          250,000 0.943396              235,849
2          250,000 0.889996              222,499
3          250,000 0.839619              209,905
4          250,000 0.792094              198,023
5      1,000,000 0.747258              747,258
         1,863,535
Amortization Table
Lease Expenses Interest Lease Obligation Amortization
0                     250,000      1,613,535
1                     250,000          96,812      1,460,347            153,188
2                     250,000          87,621      1,297,967            162,379
3                     250,000          77,878      1,125,846            172,122
4                     250,000          67,551          943,396            182,449
5                                -            56,604      1,000,000            193,396

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