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 12/31 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)

2. Assume that David Tennant Industries treated both as operating leases with less than 12 months on the term.

? 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)

3. Compare each balance sheet at 12/31/19 and each income statement prepared for FYE 12/31/19.

? Compare the differences

? Explain how the following financial ratios would be different o Current ratio o Debt service ratio o Time interest earned.

I just need 2nd and 3rd part.

Answer 1

Ans:

Matt Smith Song Industrial

Five Steps Equipment:-

1. The lease transfers ownership of the underlying asset

to the lessee by the end of the lease term NO NO

2. The lease grants the lessee an option to purchase the underlying

asset that the lessee is reasonably certain to exercise NO NO

3. The underlying asset is of such a specialized nature that it is

expected to have no alternative use to the lessor at the

end of the lease term YES NO

4. The lease term is for the major part of the remaining economic

life of the underlying asset. However, if the commencement date

falls at or near the end of the economic life of the underlying asset, YES NO

this criterion shall not be used for purposes of classifying the lease

5. The present value of the sum of the lease payments and any residual

value guaranteed by the lessee equals or exceeds substantially all YES NO

of the fair value of the underlying asset

If any of the one condition is satisfied then it is financial lease, otherwise operating lease.

Hence Matt Smith Equipment is consider as a financial lease & Song industrial is classified as operating lease