5-20. Capital Assets Acquired under Lease Agreements. (LO5-2) The City o Clear L
ID: 2337498 • Letter: 5
Question
5-20. Capital Assets Acquired under Lease Agreements. (LO5-2) The City o Clear Lake signed a lease agreement with Mountainside Builders whereby Mountainside will construct a new office building for city administrative use and lease it to the City for 30 years. The fair market value of the building is S12 million. The City has agreed to make an initial payment of $822,441 and annual payments in the same amount for the next 29 years. (This assumes a 6 percent discount rate.) The lease includes a funding clause, which allows Clear Lake to terminate the lease agreement if the government does not ap- propriate funds for the lease payments. Clear Lake does not intend to exercise this option unless there is a financial emergency. Upon completion, the build- ing had an appraised value of $13 million and an estimated useful life of 40 years.Explanation / Answer
The present value of lease payments is approx $12000000
Fair Value at the time of lease agreement is $13000000
% lease payment to fair value of building =$12000000/$13000000*100=92.30%
Lease of newly constructed building is a capital lease as total lease payments exceeds 90% of the lease asset fair value.
Lease term % based on estimated useful life of building is 30/40 =75%
Lease is a capital lease as lease term is for a period 75% of estimated life of lease asset.
a) Journal Entries
Date Account Title Dr Cr
Expenditure $12000000
To Cash $822441
To Other Financial Sources $11177559
Capital lease Agreement
To record capital lease and down payment
Buildings $12000000
To Cash $822441
To Capital lease obligations $11177559
Payable
to record capital lease and lease
payments payable
b. In Case of Accounting for capital lease
In case of present value of an obligation in the financial statements
It records a debit entry in the fixed asset and corresponding credit entry to the capital lease liability on the balance sheet.
In case of Monthly lease payments
It makes a credit to the cash account a debit to the interest expense account and debit to the capital lease liability account.
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