Question

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 12/31of 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

·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)

Answer 1

1. Tardis equipment

As the lease term is(100%) formore than 75% of the useful economic life of the asset, this isaccounted as a CAPITAL lease in the books of David TennantIndustries Inc.

2. Song Industrial sonicscrewdriver

The lease conveys no transferof ownership at the end of the term.

No purchase option and noguarantee of residual value

Lease term does not measureupto 75% of the useful economic life of the asset

Present Value of the 3 minimumYear-end payments of $ 10000 at the implicit rate of 5%is- 10000*(1-1.05^-3)/0.05= $ 27232 which is much less than90% of the fair value of $ 75000 (67500)

So, this is not a capitallease but

to be accounted as anOPERATING lease.

TardisEquipment--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 Leaseamortisation
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 sheetitems
For 12/31 /2019
Assets
Leased Equipment	108237
Less: Accumulated depreciation	43295
Equipment,net		64942
Liabilities
Long-term liabilities
Capital lease liability for leasedequipment		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