Tuesday 26 July 2016

Your employer, Wagner Inc., is a large Canadian public company

Your employer, Wagner Inc., is a large Canadian public company that uses IFRS. You are working on a project to determine the effect of the proposed contract-based approach on the corporate accounting for leases. To get started on the project, you have collected the following information with respect to a lease for a fleet of trucks used by Wagner to transport completed products to warehouses across the country. The trucks have an economic life of eight years. The lease term is from July 1, 2011, to June 30, 2018, and the company intends to lease the equipment for this period of time, so the lease term is seven years. The lease payment per year is $545,000, payable in advance, with no other payments required, and no renewal option or bargain purchase option available. The expected value of the fleet of trucks at June 30, 2018, is $450,000; this value is guaranteed by Wagner. The leased trucks must be returned to the lessor at the end of the lease. Wagner’s management is confident that with an aggressive maintenance program, Wagner has every reason to believe that the asset’s residual value will be more than the guaranteed amount at the end of the lease term. Wagner’s incremental borrowing rate is 8%, and the rate implicit in the lease is not known. At the time the lease was signed, the fair value of the leased trucks was $3,064,470.

Instructions
(a) Based on the original information:
1. Using time value of money tables, a financial calculator, or computer spreadsheet functions, determine the contractual obligations and rights under the lease at July 1, 2011.
2. Prepare an amortization schedule for the obligation over the term of the lease.
3. Prepare the journal entries and any year-end (December 31) adjusting journal entries made by Wagner Inc. in 2011 and up to and including July 1, 2012.
(b) Immediately after the July 1, 2012 leased payments, based on the feedback of the staff in operations, management reassesses its expectations for the guaranteed residual value. Management now estimates the fleet of trucks to have a value of $400,000 with a 60% probability and $300,000 with a 40% probability.
1. Calculate the probability-weighted expected value of the residual at the end of the lease term. Also calculate the present value at July 1, 2012, of any additional cash flows related to the residual value guarantee.
2. Prepare any necessary entry to implement the revision to the contractual lease rights  and obligation at July 1, 2012.
3. Revise the amortization schedule effective January 1, 2013, for the lease, including any liability related to the residual value guarantee.
4. Prepare the year-end adjusting journal entries made by Wagner Inc. for fiscal year 2012.


(a)
1. Contractual obligations and rights under lease, July 1, 2011.

Using tables:
  PV of lease payments   $545,000 X 5.62288* $3,064,470
  *  Annuity due Table A-5 at 8%

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:

PV
 $     ?  
Yields $3,064,469.42
I
8%

N
                     7

PMT
 $ 545,000

FV
 $  0

Type
                     1


2.                     Wagner Inc.
               Lease Amortization Schedule
                                                                                                                                   

   Date

            Annual
Lease
Payments

Interest (8%)
on Unpaid
Obligation

   Reduction
of Lease
Obligation

        Balance
of Lease
Obligation









 $3,064,470
July 1
2011
   $ 545,000



  $545,000

   2,519,470
July 1
2012
    545,000

  $201,558

  343,442

   2,176,028
July 1
2013
    545,000

  174,082

  370,918

   1,805,110
July 1
2014
    545,000

  144,409

  400,591

   1,404,519
July 1
2015
    545,000

  112,361

  432,639

      971,880
July 1
2016
    545,000

     77,750

  467,250

      504,630
July 1
2017
    545,000

     40,369
*
  504,631

              (0)
* one dollar rounding

3.
July 1, 2011
   
    Contractual Lease Rights........ 3,064,470
        Contractual Lease Obligations                         3,064,470

    Contractual Lease Obligations...    545,000
        Cash ......................               545,000

December 31, 2011
    Interest Expense................    100,779
        Interest Payable...........               100,779
        ($201,558 X 6 / 12 = $100,779)

    Amortization  Expense...........    218,891
        Contractual Lease Rights...               218,891
        ($3,064,470 ÷ 7 years X 6/ 12 = $218,891)

July 1, 2012
    Interest Expense................    100,779
    Interest Payable................    100,779
    Contractual Lease Obligations...    343,442
        Cash ......................               545,000

(b)   
1.   Probability-weighted expected value of residual
     $400,000 X 60% =           $240,000
     $300,000 X 40% =            120,000
     Probability-weighted value  360,000
     Guaranteed value            450,000
     Liability July 1, 2018      $90,000
                                       
To calculate the present value of this additional cash outflow:
Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:

PV
 $     ?  
Yields $56,715
I
8%

N
                     5

PMT
 $ 0

FV
 $ 90,000

Type
                     1


2.
July 1, 2012
Contractual Lease Rights............    56,715
        Contractual Lease Obligations                         56,715

     The carrying amount of the lease obligation after the above entry is $2,232,743 (balance from the original amortization schedule $2,176,028 after the July 1, 2012 payment + $56,715)

3.                     Wagner Inc.
     Lease Amortization Schedule—Revised July 1, 2012

                                                                                                                                   

   Date

            Annual
Lease
Payments

Interest (8%)
on Unpaid
Obligation

   Reduction
of Lease
Obligation

        Balance
of Lease
Obligation









  $ 2,232,743
July 1
2013
   $ 545,000

 $ 178,619

  $366,381

   1,866,362
July 1
2014
    545,000

  149,309

  395,691

   1,470,671
July 1
2015
    545,000

  117,654

  427,346

   1,043,325
July 1
2016
    545,000

     83,466

  461,534

      581,791
July 1
2017
    545,000

     46,543

  498,457

         83,334
July 1
2018
      90,000

       6,666
*
    83,334

                 (0)
 * one dollar rounding

4.
December 31, 2012
    Interest Expense................     89,310
        Interest Payable...........                89,310
        ($178,619 X 6 ÷ 12 = $89,310)

    Amortization  Expense...........    483,716
        Contractual Lease Rights...               483,716
        ($2,902,294* ÷ 6 years = $483,716)

* Original entry for the rights  $3,064,470
     Amortization recorded in 2011    (218,891)
     Adjustment for residual value      56,715
     Amortizable balance            $2,902,294