Question

Larkspur Leasing Company signs a lease agreement on January 1, 2017, to lease electronic equipment to Crane Company. The term of the non-cancelable lease is 2 years, and payments are required at the end of each year. The following information relates to this agreement: 1. Crane has the option to purchase the equipment for $15,500 upon termination of the lease. It is not reasonably certain that Crane will exercise this option. 2. The equipment has a cost of $110,000 and fair value of $158,500 to Larkspur Leasing. The useful economic life is 2 years, with a residual value of $15,500. 3. Larkspur Leasing desires to earn a return of 5% on its investment. 4. Collectibility of the payments by Larkspur Leasing is probable.

Prepare the journal entries on the books of Larkspur Leasing to reflect the payments received under the lease and to recognize income for the years 2017 and 2018.

Answer 1

About the meeting the criteria for a capital lease:

1. The lease is silent about transfer of ownership to Crane(lessee) at the end of lease term.

2.Bargain purchase option by Crane,at the end of lease term. is not reasonably certain .

3. Lease term of 2 yrs. Is > 75% of the useful economic life of the asset (it is 100%) & the lease is non-cancelable during this period.

4. PV of minimum lease payments is not provided in the lease & annual lease payments have to be calculated with the Fair value to Laskar given.

Point no. 3 is satisfied in the above.

But as far as the two additional conditions for the lessor,

a.Collectibility of the minimum lease payments is only probable & not reasonably certain or assured; and

b. the terms are silent about ,any important uncertainties with regard to unreimbursable costs that are yet to be incurred by Larkspur,the lessor

For a lease to be classified as a capital lease by the lessor, any one of the first 4 criteria & both the second set of criteria are to be met.

In this case, only the point a is partially met & b. is not met.

In light of the above, this lease is NOT a CAPITAL LEASE & to be treated as an OPERATING lease only--- where the lessor records the entire lease payment as revenue & depreciates the asset , in his books

So, proceeding on the above lines,

The annual payments are calculated using the PV of annuity formula:

158500=Pmt.*(1-1.05^-2)/).05

Solving the above,

the annual minimum lease payments is

85242

Books of Larkspur Leasing
31-Dec-17	Cash	85242
	Lease Rent Revenue		85242
	Depreciation expense	47250
	Accumulated depn.		47250
	(110000-15500)/2
31-Dec-18	Cash	85242
	Lease Rent Revenue		85242
	Depreciation expense	47250
	Accumulated depn.		47250
	(110000-15500)/2
Income to be recognised for both the years 2017 & 2018:
Rental revenue-Depreciation
85242-47250=
37992