Question

In: Accounting

David Tennant Industries Inc leases TARDIS equipment from Matt Smith Equipment Corp for five years on...

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)

Solutions

Expert Solution

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

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