Assume
the same data as in P20–13 and that Provincial Airlines Corp. has an
incremental borrowing rate of 8%.
Instructions
Answer
the following questions, rounding all numbers to the nearest dollar.
(a)
Discuss the nature of this lease in relation to the lessee.
(b)
What classification will Provincial Airlines Corp. give to the lease?
(c)
What difference, if any, would occur in the classification of the lease if
Provincial were using IFRS?
(d)
Using time value of money tables, a financial calculator, or computer
spreadsheet functions, calculate the amount of
the
initial obligation under capital leases.
(e)
Prepare a 10-year lease amortization schedule for the lease obligation using a
computer spreadsheet.
(f)
Prepare all of the lessee’s journal entries for the first year, assuming that
the lease year and Provincial Airlines’ fiscal year are the same.
(g)
Prepare the entries in (f) again, assuming that the residual value of $15,000
was guaranteed by the lessee.
(h)
Prepare the entries in (f) again, assuming a residual value at the end of the
lease term of $45,000 and a purchase option of $15,000.
(a) For the lessee under PE GAAP, rather than using
quantitative factors described under part (b) below for IFRS, quantitative
criteria such as:
1. the term of the lease exceeding 75% of the remaining
economic life of the asset,
2. the present value of the minimum lease payments
exceeding 90% of the fair value of the asset, or
3. the presence of a bargain purchase option will be
applied as the basis for the classification of the lease.
(b) It will be classified as a direct financing
lease for Provincial Airlines Corp. because:
(1)
the lease term is 75% or more of the asset’s economic life and (2) the present
value of the minimum lease payments exceeds 90% of the fair value of the leased
asset.
(c) The IFRS criteria use qualitative factors
to establish whether or not the risks and rewards of ownership are transferred
to the lessee, and supports classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of the lease term. If there
is a bargain purchase option in the lease, it is assumed that the lessee will
exercise it and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that are expected to be
derived from using the leased property over its life.
3. The lease allows the lessor to recover substantially
all of its investment in the leased property and to earn a return on the
investment. Evidence of this is provided if the present value of the minimum
lease payments is close to the fair value of the leased asset.
4. The leased assets are so specialized that, without
major modification, they are of use only to the lessee.
The lease would be classified as a finance lease.
(d) Initial
Obligation Under Capital Leases:
Minimum
lease payments ($25,000) X PV of an
annuity due for 10 periods at 8% (7.24689) $181,172
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Excel formula =PV(rate,nper,pmt,fv,type)
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Using a financial calculator:
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PV
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$
?
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Yields $181,172
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I
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8%
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N
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10
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PMT
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$
(25,000)
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FV
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$
0
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Type
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1
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(e) Provincial
Airlines Corp. (Lessee)
Lease Amortization
Schedule
(Annuity due basis
and URV)
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Beginning
of Year
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Annual
Lease
Payment
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Interest (8%)
on Unpaid
Obligation
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Reduction
of Lease
Obligation
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Lease
Obligation
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Initial PV
1
2
3
4
5
6
7
8
9
10
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(a)
—
$25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
$250,000
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(b)
—
—
*$12,494*
* 11,493*
* 10,413*
* 9,246*
* 7,985*
* 6,624*
* 5,154*
* 3,566*
* 1,853*
*$68,828*
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(c)
—
$ 25,000
12,506
13,507
14,589
15,754
17,015
18,376
19,846
21,434
23,147
$181,172
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(d)
$181,172
156,172
143,666
130,159
115,572
99,818
82,803
64,427
44,581
23,147
0
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*Rounding
error is $1.
(a) Annual lease payment required by lease
contract.
(b) Preceding
balance of (d) X 8%, except beginning of first year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(f) Lessee’s journal entries:
Beginning
of the Year
Leased Equipment...................... 181,172
Lease
Obligation.................. 181,172
(To record the lease of equipment
using capital lease method)
Lease Obligation...................... 25,000
Cash.............................. 25,000
(To record the first rental payment)
End of the Year
Interest Expense...................... 12,494
Interest
Payable.................. 12,494
(To record accrual of annual interest on
lease obligation)
Depreciation Expense.................. 18,117
Accumulated
Depreciation—Leased
Equipment....................... 18,117
(To record depreciation expense for
first year [$181,172 ÷ 10])
(g) Refer to the calculations
and table of P20-13 for the amounts using the guaranteed residual value in the
calculations of payments made by the lessee Provincial Airlines Corp.
Beginning
of the Year
Leased Equipment...................... 188,120
Lease
Obligation.................. 188,120
(To record the lease of equipment
using capital lease method)
Lease Obligation...................... 25,000
Cash.............................. 25,000
(To record the first rental payment)
End of the Year
Interest Expense...................... 13,050
Interest
Payable.................. 13,050
(To record accrual of annual interest on
lease obligation)
Depreciation Expense.................. 17,312
Accumulated Depreciation—Leased
Equipment....................... 17,312
(To record depreciation expense for
first year [$188,120 - $15,000 ÷ 10])
(h) The residual value of
$45,000 will not be included in calculation of the present value of the minimum
lease payments. Rather, the bargain purchase option of $15,000 will be the
future outflow in the calculations below. The bargain purchase option will
permit depreciation of the equipment over its economic life of 12 years.
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Excel formula =PV(rate,nper,pmt,fv,type)
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Using a financial calculator:
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PV
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$
?
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Yields $188,120
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I
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8%
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N
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10
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PMT
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$ (25,000)
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FV
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$ (15,000)
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Type
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1
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Beginning
of the Year
Leased Equipment...................... 188,120
Lease
Obligation.................. 188,120
(To record the lease of
equipment using capital lease method)
Lease Obligation...................... 25,000
Cash.............................. 25,000
(To record the first rental payment)
End of the Year
Interest Expense...................... 13,050
Interest
Payable.................. 13,050
(To record accrual of annual interest on
lease obligation)
[($188,120 -
$25,000) X 8%]
Depreciation Expense.................. 15,677
Accumulated
Depreciation—Leased
Equipment....................... 15,677
(To record depreciation expense for
first year [$188,120 ÷ 12])
