Ask Question, Ask an Expert

+1-415-315-9853

info@mywordsolution.com

Ask Financial Accounting Expert

Lessee Ltd., the British company which applies IFRSs, leased equipment from Lessor Inc. on January 1, 2007, for period of three years. Lease payments of $100,000 are due to Lessor Inc. each year. Other expenses (like insurance, taxes, maintenance) are also to be paid by Lessee Ltd. and amount to $2,000 per year. Lessor did not incur any initial direct costs. Lease contains no purchase or renewal options and equipment reverts back to Lessor Inc. on expiration of the lease. The remaining useful life of the equipment is four years. Fair value of the equipment at lease inception is $265,000. Lessee Ltd. has guaranteed $20,000 as the residual value at the end of lease term. $20,000 represents the expected value of the leased equipment to the lessee at the end of a lease term. Salvage value of an equipment is expected to be $2,000 after the end of its economic life. Lessee’s incremental borrowing rate is 11 percent (Lessor’s implicit rate is 10 percent and is calculable by lessee from the lease agreement).

Junior accountant of Lessee Ltd. analyzed assets under lease and prepared the computation. The senior accountant of Lessee Ltd. reviewed the analysis and the computation and prepared a separate analysis. As the finance controller, you were given both of the computations to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant are below.

Present Value of the Lease Obligation:

Using rate implicit in lease (10 percent), present value of a guaranteed residual value would be $15,026 ($20,000 × 0.7513), and present value of annual payments would be $248,690 ($100,000 × 2.4869).

Using incremental borrowing rate (11 percent), present value of the guaranteed residual value would be $14,624 ($20,000 × 0.7312), and present value of the annual payments would be $244,370 ($100,000 × 2.4437).

Computations by junior accountant:

As the equipment reverts back to Lessor Inc., it is the operating lease.
Entries to be posted in Years 1, 2, and 3:
Dr. Lease expense:      $100,000
Dr. Insurance expense: $2,000
Cr. Cash:                   $102,000
(Operating lease rental paid to Lessor Inc.)

Computations by senior accountant:

Step 1: Lease classification
Lease term is for three years. The useful life of the equipment is four years. As the lease term is for a major part of the useful life of the equipment, it is a finance lease.

Step 2: Computation of lease asset and obligation
As the lessee’s incremental borrowing rate is greater than the lessor’s implicit rate in the lease, compute the present value of the minimum lease payments using the 11 percent rate.
Present value of the minimum lease payments = $100,000 × 2.4437 = $244,370.

Step 3: Allocation of payments between interest and lease obligation
Since interest has to be charged on the straight-line method, the following is the allocation of the interest and the reduction in the lease liability.

Year    Cash Payment          Interest Expense (11%)     Reduction in Lease Obligation   Balance of Lease Obligation
                   $                                       $                                      $                                    $
0
                                                                                                                                        244,370
1              100,000                              26,881                                73,119                              171,251
2              100,000                              26,881                                73,119                               98,131
3              100,000                              26,881                                73,119                               25,012

Journal entry in Year 1 to record the payments:
Dr. Rent expense:      $2,000
Dr. Interest expense: $26,881
Dr. Lease obligation:  $73,119
Cr. Cash:                 $102,000

Required:
1. Was the junior accountant’s analysis correct? Why or why not?
2. Was the senior accountant’s analysis correct? Why or why not?
3. How would the answer differ under U.S. GAAP?

Financial Accounting, Accounting

  • Category:- Financial Accounting
  • Reference No.:- M9376

Have any Question? 


Related Questions in Financial Accounting

Cash budget extra creditrahman products a distributor of

Cash Budget Extra Credit Rahman Products, a distributor of organic beverages, needs a cash budget for December. The following information is available: a. The cash balance at the beginning of December $12,000. b. Actual ...

Select a violent female offender 2 pages bull describe the

Select a violent female offender 2 pages • Describe the violent female offender you selected. • Describe any social, environmental, psychological, and/or biological factors that may have contributed to the crime and expl ...

Problem 1millar company has the following cost records for

PROBLEM 1 Millar Company has the following cost records for May 2016 Indirect factory labor $ 10,000 Advertising Expense $ 8,000 Direct materials used 13,000 Depreciation, factory equipment 4,200 Work in process, 5/1/15 ...

Mohammed abul and his family own the long-lasting boot llb

Mohammed Abul and his family own the Long-lasting Boot (LLB) store. LLB is a specialty boot store located in the downtown area in a medium sized Scottsdale, Arizona and sells a broad line of boots to all members of the f ...

Choose one of the following two assignments to complete

Choose one of the following two assignments to complete this week. Do not do both assignments. Identify your assignment choice in the title of your submission. Option #1: Income Statement, Retained Earnings, and Balance ...

What are some different ways you could communicate a

What are some different ways you could communicate a concept for a new user interface for an automotive audio system? What are the strengths and weaknesses of each approach?

Assignmentthe kroger company reported the following data in

Assignment The Kroger Company reported the following data in its annual report (in millions).   January 31, 2015 February 1, 2014 February 2, 2013 Net sales $108,465 $98,375 $96,619 Cost of sales (using LIFO) 85,512 78,1 ...

The market environment heavily influences corporate

The market environment heavily influences corporate decision-making ability. Identify the differences in executive decisions concerning pricing, product design, and advertising between a company in a competitive market a ...

Course projectfinancial statement analysislearning

COURSE PROJECT FINANCIAL STATEMENT ANALYSIS Learning Objectives • Analyze a company's financial statements in terms of liquidity, profitability and long-term solvency, and cash flows from operations. • Prepare in good fo ...

Assignmentswish watch corporation manufactures sells and

Assignment Swish Watch Corporation manufactures, sells, and services expensive, ugly watches. The company has been in business for three years. At the end of the most recent year, 2006, the accounting records reported to ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

WalMart Identification of theory and critical discussion

Drawing on the prescribed text and/or relevant academic literature, produce a paper which discusses the nature of group

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro