In: Accounting
David Tennant Industries Inc leases TARDIS equipment from Matt Smith Equipment Corp for five years on 1/1/18 at $25,000 per year. The equipment has a five year economic life. Lease payments are due on 12/31 of each year (not on 1/1 of each year). David Tennant Industries does not know Matt’s Smith’s implicit interest rate but their incremental borrowing rate is 5%. The lease conveys no transfer of ownership at the end of the term. There is no purchase option and no guarantee of residual value. Similar assets are depreciated on a straight line basis.
David Tennant Industries also leases a sonic screwdriver from Song Industrial for three years starting 1/1/18. The machine has a fair value of $75,000, a 100 year economic life, and Song Industrial has other uses for it after the lease term. The lease calls for payment of $10,000 a year due on 12/31 of each year. The implicit rate is known and is 5%. The lease conveys no transfer of ownership at the end of the term. There is no purchase option and no guarantee of residual value.
? Determine the journal entries for 12/31/18 and 1/1/19 and 12/31/19 ?
? Prepare a schedule of items and their values which will appear on the balance sheet as of
12/31/19
? Prepare a schedule of items and their values which will appear on the income statement for the
year ended 12/31/19
? Prepare a schedule of items and their values which will appear on the statement of cash flows
for the year ended 12/31/19 (assuming the indirect method)
1. Tardis equipment |
As the lease term is(100%) for more than 75% of the useful economic life of the asset, this is accounted as a CAPITAL lease in the books of David Tennant Industries Inc. |
2. Song Industrial sonic screwdriver |
The lease conveys no transfer of ownership at the end of the term. |
No purchase option and no guarantee of residual value |
Lease term does not measure upto 75% of the useful economic life of the asset |
Present Value of the 3 minimum Year-end payments of $ 10000 at the implicit rate of 5% is- 10000*(1-1.05^-3)/0.05= $ 27232 which is much less than 90% of the fair value of $ 75000 (67500) |
So, this is not a capital lease but |
to be accounted as an OPERATING lease. |
Tardis Equipment--Capital Lease | |||
At inception of the lease | |||
1/1/2018 | Leased Equipment | 108237 | |
Capital Lease liability | 108237 | ||
25000*(1-1.05^-5)/0.05 | |||
12/31/2018 | Depreciation expense | 21647 | |
Accumulated Depn.-Leased equipment | 21647 | ||
(108237/5) | |||
Interest expense(108237*5%) | 5412 | ||
Capital Lease liability(25000-5412) | 19588 | ||
Cash | 25000 | ||
1/1/2019 | NO ENTRY | ||
12/31/2019 | Depreciation expense | 21647 | |
Accumulated Depn.-Leased equipment | 21647 | ||
(108237/5) | |||
Interest expense((108237-19588)*5%) | 4432 | ||
Capital Lease liability(25000-5412) | 20568 | ||
Cash | 25000 | ||
Capital Lease amortisation | ||||
Year | Annuity payment | Tow. Int. | Tow. Principal | Prin. Bal. |
0 | 108237 | |||
1 | 25000 | 5412 | 19588 | 88649 |
2 | 25000 | 4432 | 20568 | 68081 |
3 | 25000 | 3404 | 21596 | 46485 |
4 | 25000 | 2324 | 22676 | 23810 |
5 | 25000 | 1190 | 23810 | 0 |
Song Industrial--- Operating Lease | |||
1/1/2018 | NO ENTRY | ||
12/31/2018 | Lease rental expense | 10000 | |
Cash | 10000 | ||
1/1/2019 | NO ENTRY | ||
12/31/2019 | Lease rental expense | 10000 | |
Cash | 10000 | ||
2. Balance sheet items | ||
For 12/31 /2019 | ||
Assets | ||
Leased Equipment | 108237 | |
Less: Accumulated depreciation | 43295 | |
Equipment,net | 64942 | |
Liabilities | ||
Long-term liabilities | ||
Capital lease liability for leased equipment | 68081 |
3. Income Statement | ||
For the Yr. ended 12/31/2019 | ||
Depreciation expense | 21647 | |
Interest expense | 4432 | |
Lease rentals | 10000 | |
4. Cash flow statement (partial) | ||
Operating activities: | ||
Net Income as per Income statement | ||
Add: Non-cash charges | ||
Depreciation expense | 21647 | |
Investing activities | ||
Financing activities | ||
Installment tow.lease liability | -20568 |