WILL AWARD POINTS AND LIFESAVER TO THE EASIEST TO UNDERSTAND AND RIGHT ANSWER. Q

Question

WILL AWARD POINTS AND LIFESAVER TO THE EASIEST TO UNDERSTAND AND RIGHT ANSWER.

Question (2): Accounting for leases

Simons Company leased a machine from an established machine dealer, Machine Guarantee Limited. The dealer acquired the machine at a cost of $180,000. The cost of repairing the machine to make it suitable for another owners will be $40,000. Simons Company plans to keep the machine after the lease but has not made any commitment to the lessor to purchase it. The terms of the lease are as follows:

· Date of entering lease: July 1, 2011

· Duration of lease: 4 years

· Life of leased asset: 5 years, after which it will have no salvage value

· Lease payments: $100,000 at the end of each year

· Interest rate implicit in the lease: 10%

· Unguaranteed residual: $50,000

· Fair value of truck at inception of the lease: $351, 140

Required:

(i) Prepare the journal entries to account for the lease transaction in the books of the lessor, Machine Guarantee Limited.

(ii) Prepare the journal entries to account for the lease transaction in the books of the lessee, Simons Limited.

Explanation / Answer

Lessor :Machine Guarantee Limited (MGL)

Lessee: Simons Limited (SL)

As Lease is for >75% of Economic life, It is capital Lease.

(i) Journal entry by Lessor MGL :

Cost/FMV of asset to be recovered $351,140

Less: PV of expected residue value 50000*PV(10%,4)= 50000*0.6830 = $34,150

---------------------------------------------

Amount to be recovered through lease Pmts $316,990

1Jul11 Lease Rxable Dr 351,140

Eqpt Cr 316,990

Unearned Int Rev Cr 34,150

30Jun12 Cash Dr 100,000

Lease Rxable Cr 100,000

30 Jun12 Unearned Int Rev Dr 8538

Int Rev Cr 8538

(Int Rev 34150/4 = 8538)

(ii) Journal entry by Lessee SL :

1Jul11 Leased Eqpt Dr 351,140

Lease Obligation Cr 351,140

30 Jun12 Lease Liability Dr 100,000

Cash Cr 100,000

As this is a capital lease the following must also be recorded (at year end or in each reporting period)

viz. Interest expense & Asset amortization

30Jun12 Interest Expense Dr 25,114

Interest Payable Cr 25,114

(To record int amortization. Int = (351140-100000)*10% =25114. Interest Payable is debited in all subsequent lease payment entries)

30Jun12 Amortization Expense Dr$ $87,785

Accumulated Amortization Cr $87,785

(To record asset amortization=351140/4 =$87,785 )

(There is no transfer of ownership or bargain purchase option, so the term of the lease is used to amortize the asset)

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