Dubois
Steel Corporation, as lessee, signed a lease agreement for equipment for five
years, beginning January 31, 2011. Annual rental payments of $41,000 are to be
made at the beginning of each lease year (January 31). The taxes, insurance,
and maintenance costs are the lessee’s obligation. The interest rate used by
the lessor in setting the payment schedule is 9%; Dubois’ incremental borrowing
rate is 10%. Dubois is unaware of the rate being used by the lessor. At the end
of the lease, Dubois has the option to buy the equipment for $4,000, which is
considerably below its estimated fair value at that time. The equipment has an
estimated useful life of seven years with no residual value. Dubois uses
straight-line depreciation on similar equipment that it owns, and follows IFRS.
Instructions
Answer
the following questions, rounding all numbers to the nearest dollar.
(a)
Prepare the journal entry or entries, with explanations, that should be
recorded on January 31, 2011, by Dubois.
(b)
Prepare any necessary adjusting journal entries at December 31, 2011, and the
journal entry or entries, with explanations, that should be recorded on January
31, 2012, by Dubois. (Prepare the lease amortization schedule for the lease obligation
using a computer spreadsheet for the minimum lease payments.) Dubois does not
use reversing entries.
(c)
Prepare any necessary adjusting journal entries at December 31, 2012, and the
journal entry or entries, with explanations, that should be recorded on January
31, 2013, by Dubois.
(d)
What amounts would appear on Dubois’ December 31, 2012 balance sheet relative
to the lease arrangement?
(e)
What amounts would appear on Dubois’ statement of cash flows for 2011 relative
to the lease arrangement? Where would the amounts be reported?
(f)
Assume that the leased equipment had a fair value of $200,000 at the inception
of the lease, and that no bargain purchase option is available at the end of
the lease. Determine what amounts would appear on Dubois’ December 31, 2012
balance sheet and what amounts would appear on the 2012 statement of cash flows
relative to the leasing arrangements.
(a) January
31, 2011
Leased
Equipment.................... 173,448
Lease
Obligation................ 173,448
(To
record leased asset and
related obligation)
PV of monthly payment of $41,000 X 4.16987*.... $170,964
PV of residual value of $4,000 X .62092**...... 2,484
Present value of minimum lease payments........ $173,448
* (PV
factor for annuity due for 5 years at 10%)
** (PV
factor for $1 for 5 years at 10%)
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Excel formula =PV(rate,nper,pmt,fv,type)
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Using a financial calculator:
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PV
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$
?
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Yields $ 173,448.17
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I
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10%
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N
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5
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PMT
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$
(41,000)
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FV
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$
(4,000)
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Type
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1
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January
31, 2011
Lease
Obligation.................... 41,000
Cash............................ 41,000
(To
record the first rental payment)
(b) December
31, 2011
Depreciation
Expense................ 22,713
Accumulated
Depreciation—Leased
Equipment..................... 22,713
(To
record depreciation of the leased
asset based upon a cost to Dubois of
$173,448 and a life of 7 years X 11/ 12)
December
31, 2011
Interest Expense........................ 12,141
Interest
Payable.................... 12,141
(To
record accrual of interest on lease
obligation $13,245 X 11 / 12)
January
31, 2012
Interest Payable........................ 12,141
Interest Expense........................ 1,104
Lease Obligation........................ 27,755
Cash................................ 41,000
(To
record annual payment on lease
obligation)
During year
Property Tax Expense................... XXX
Insurance Expense...................... XXX
Maintenance Expense.................... XXX
Cash................................ XXX
(To record payment for executory
costs)
Dubois Steel Corporation (Lessee)
Lease
Amortization Schedule
(Annuity
Due Basis)
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Date
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Annual
Lease
Payment
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Interest (10%)
on Unpaid
Obligation
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Reduction
of Lease
Obligation
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Balance
of Lease
Obligation
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1/31/11
1/31/11
1/31/12
1/31/13
1/31/14
1/31/15
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—
$41,000
41,000
41,000
41,000
41,000
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—
$ 0
13,245
10,469
7,416
4,058
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—
$41,000
27,755
30,531
33,584
36,942
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$173,448
132,448
104,693
74,162
40,578
3,636
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1/31/16
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4,000
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364*
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3,636
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* rounded
(c) December
31, 2012
Depreciation Expense.................. 24,778
Accumulated
Depreciation—Leased
Equipment....................... 24,778
(To record annual depreciation
on
assets leased $173,448 ÷ 7)
December
31, 2012
Interest Expense...................... 9,597
Interest
Payable.................. 9,597
(To
record accrual of interest on lease
obligation $10,469 X 11 ÷ 12)
January
31, 2013
Interest Payable........................ 9,597
Interest Expense........................ 872
Lease Obligation........................ 30,531
Cash................................ 41,000
(To
record annual payment on lease
obligation)
(d) Dubois Steel Corporation
Balance
Sheet
December
31, 2012
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Property, plant, and equipment:
Leased
equipment $173,448
Less: Accumulated
depreciation 47,491
$125,957
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Current liabilities:
Interest payable $9,597
Lease
obligation 30,531
Long-term:
Lease
obligation 74,162
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(e)
The
transaction securing the equipment using the finance lease would not be
reported on the statement of cash flows for the year ending December 31, 2011.
This is non-cash investing transaction, which should be described in the notes
to the financial statements. The first lease payment would appear as a cash
outflow for the debt repayment in the financing activities section of the
statement.
When using the direct method, for the operating
activities of the cash flow statement, no amounts need to appear. On the other
hand using the indirect method, adjustments to net income would include the
adding back of depreciation expense in the amount of $22,713
and the increase in the interest payable in the amount of $9,597.
(f)
Based on
these new facts, the lease would be reported as an operating lease by Dubois as
the risks and rewards of ownership are not transferred to the lessee.
Consequently, no balances would appear on the balance
sheet of Dubois at December 31, 2012. No amount would appear on the statement
of cash flows as the amount of rent expense would correspond to the lease
payment made of $41,000.
