QUESTION 1 - Your company, Wando, Inc. has been expanding rapidly this year and needs a new headquarters building. The owners of the Company cannot decide whether they want to borrow money and build a new green building, or simply have someone else build a building and they will have Wando rent it. In order to help them make a decision, you have put together some comparable numbers of the lease vs. buy decision. If they were to build the building, it would cost $2 million in total costs (we are ignoring capitalized interest), would last for 20 years and would be depreciated using the straight-line method. They would have to borrow 80% of the purchase price at an interest rate of 8% annually. You have found a comparable building available to rent for monthly rental payments of $11,418.52, excluding maintenance, property taxes, etc. The potential landlord - IOWNYOU CORPORATION - has offered a 15 year lease with a renewal option at the then prevailing fair market rental rate of an additional 5 years. The rent is always payable in full on the first day of the year (in other words, use Table 6-5 in your text). Even though the effective interest method is the preferred GAAP method, if you choose to use straight-line (assuming you think it necessary to use either one), I will not object to your answer.
a. Determine whether you think the lease, assuming you sign it, is a capital or operating lease to Wando, Inc.
b. Calculate and prepare the journal entries to show the accounting results as if you borrowed the money and built the building. Present the year of acquisition (you placed it in service on January 1, 2011 and are a December 31 year end) and the year after that.
c. Calculate and prepare the journal entries under the lease arrangement for the same two periods as part "b".
QUESTION 2 - Use the same information as QUESTION 1 plus the following additional facts which are NOT known to Wando, Inc. in QUESTION 1. IOWNYOU CORPORATION, constructed the building at a total cost of $2 million and has accumulated depreciation on the building at the date it is leased to Wando of $100,000. Presume that IOWNYOU's discount rate is 6%. IOWNYOU has completed a very intrusive background check of Wando, Inc. and its owners and concluded that Wando is creditworthy enough to enter into the lease arrangement.
a. Comment on whether you need more information to determine whether this lease arrangement is a capital (direct-financing lease) or an operating lease to IOWNYOU.
b. Based upon the information, calculate and prepare the journal entries for IWONYOU for just the first year of the lease based upon what you concluded in part "a".