Question 1 - Leases

Beta Company leases an asset to Omega Company for 10 years beginning January 1, Year 1 at an annual rental of $5,000. Beta's (lessor) implicit borrowing rate (implicit rate in th elease) of 10% is known to Omega (lesseee). Omega's incremental borowing rate is 12%, The first payment is due at the beginning of teh first year. The asset's economic life is 12 years and the Fair Value of the asset at the inception of the lease is $34,000. The lease requires Omega to pay the $2,000 annual executory costs. The lease does not transfer ownership or contain a bargain purchase option.

Use the appropriate Present Value Amounts from below:

PV of an annuity due of $1 for 10 periods at 10% = 6.759

PV of an annuity due of $1 for 10 periods at 11% = 6.537

Required:

(a) Is this a Capital Lease to the Lessee? If so, which criteria was met?

(b) Prepare all necessary journal entries at January 1, Year 1?

(c) Prepare all necessary journal entries at December 31, Year 1?

(d) Prepare journal entries at January 1, Year 2?

Question 2 - Accounting Change and Error Correction

On December 31, 2010, before the books were closed, the management and accountants of Baker Inc made the following determinations about three depreciable assets:

1. Depreciable asset A was purchased January 1, 2006. It originally cost $620,000 and, for depreciation purposes, the straight-line method was originally chosen. The asset was originally expected to be useful for 10 years and have a zero salvage value. In 2010 the decision was made to change the depreciation method from sum-of-the-years'-digits to straight-line, and the estimates relating to useful life and salvage value remained unchanged.

2. Depreciable asset B was purchased January 1, 2006. It originally cost $125,000 and was depreciated on the straight-line method basis. The asset was originally expected to be useful for 15 years and a salvage value of $5,000. In 2010, the decision was made to shorten the total life of this asset to 10 years and to estimate the salvage value at $2,000.

3. Depreciable asset C was purchased January 1, 2006. The asset's original cost was $180,000, and this amount was entirely expensed in 2006. This particular asset has a 8-year useful life and no salvage value. The straight-line method was used for depreciation.

Additional data:

Income in 2010 before depreciation expense amounted to $380,000

Depreciation expense on assets other than A, B, and C totaled $70,000 in 2010.

Income in 2009 was reported at $350,000

Ignore all income tax effects.

100,000 shares of common stock were outstanding in 2009 and 2010.

Required:

a) Prepare all necessary journal entries in 2010 to record these determinations.

b) Prepare comparative retained earnings statements for Baker Inc for 2009 and 2010. The company had retained earnings of $150,000 at December 31, 2008.