Lease Paper 3

1

Leases should be classified by the lessee as either operating leases or capital leases. Which of the following statements best characterizes operating leases?






2

Peg Co. leased equipment from Howe Corp. on July 1, year 1 for an eight-year period expiring June 30, year 9. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, year 1. The rate of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe’s accounting records is $2,800,000. The lease is appropriately recorded as a sales-type lease. What is the amount of profit on the sale and interest revenue that Howe should record for the year ended December 31, year 1?
Profit on sale
Interest revenue






3

Howe Co. leased equipment to Kew Corp. on January 2, year 1, for an eight-year period expiring December 31, year 8. Equal payments under the lease are $600,000 and are due on January 2 of each year. The first payment was made on January 2, year 1. The list selling price of the equipment is $3,520,000 and its carrying cost on Howe’s books is $2,800,000. The lease is appropriately accounted for as a sales-type lease. The present value of the lease payments is $3,300,000. What amount of profit on the sale should Howe report for the year ended December 31, year 1?






4

The excess of the fair value of leased property at the inception of the lease over its cost or carrying amount should be classified by the lessor as






5

In a lease that is recorded as a sales-type lease by the lessor, interest revenue






6

Lease M does not contain a bargain purchase option, but the lease term is equal to 90% of the estimated economic life of the leased property. Lease P does not transfer ownership of the property to the lessee at the end of the lease term, but the lease term is equal to 75% of the estimated economic life of the leased property. How should the lessee classify these leases?
Lease M
Lease P






7

On December 31, year 1, Day Co. leased a new machine from Parr with the following pertinent information:
Lease term 6 years
Annual rental payable at beginning of each year $50,000
Useful life of machine 8 years
Day’s incremental borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of annuity of 1 in advance for 6 periods at 12% 4.61
15% 4.35
The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr’s accounting records is $375,500. At the beginning of the lease term, Day should record a lease liability of






8

On January 1, year 1, Day Corp. entered into a ten-year lease agreement with Ward, Inc. for industrial equipment. Annual lease payments of $10,000 are payable at the end of each year. Day knows that the lessor expects a 10% return on the lease. Day has a 12% incremental borrowing rate. The equipment is expected to have an estimated useful life of ten years. In addition, a third party has guaranteed to pay Ward a residual value of $5,000 at the end of the lease.
The present value of an ordinary annuity of $1 at
12% for ten years is 5.6502
10% for ten years is 6.1446
The present value of $1 at
12% for ten years is .3220
10% for ten years is .3855
In Day’s October 31, year 1 balance sheet, the principal amount of the lease obligation was






9

Robbins, Inc. leased a machine from Ready Leasing Co. The lease qualifies as a capital lease and requires ten annual payments of $10,000 beginning immediately. The lease specifies an interest rate of 12% and a purchase option of $10,000 at the end of the tenth year, even though the machine’s estimated value on that date is $20,000. Robbins’ incremental borrowing rate is 14%.
The present value of an annuity due of one at
12% for ten years is 6.328
14% for ten years is 5.946
The present value of one at
12% for ten years is .322
14% for ten years is .270
What amount should Robbins record as lease liability at the beginning of the lease term?






10

Neal Corp. entered into a nine-year capital lease on a warehouse on December 31, year 1. Lease payments of $52,000, which includes real estate taxes of $2,000, are due annually, beginning on December 31, year 2, and every December 31 thereafter. Neal does not know the interest rate implicit in the lease; Neal’s incremental borrowing rate is 9%. The rounded present value of an ordinary annuity for nine years at 9% is 5.6. What amount should Neal report as capitalized lease liability at December 31, year 1?






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