On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The fo
ID: 2462390 • Letter: O
Question
On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The following information pertains to this lease. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease. Equal rental payments are due on January 1 of each year, beginning in 2011. The fair value of the equipment on January 1, 2011, is $200,000, and its cost is $150,000. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Woods depreciates all of it equipment on a straight-line basis. Palmer sets the annual rental to ensure an 11% rate of return. Woods’ incremental borrowing rate is 12%. The implicit rate of the lessor is not known to Woods. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
REQUIRED: a) Discuss the nature of this lease to Woods.
b) Prepare all the necessary journal entries for Woods through January 1, 2012.
c) Discuss the nature of this lease to Palmer.
d) If the cost of this lease had been $200,000, how with this have changed your answer to Part (c)?
e) Had the title of the lease transferred at the end of the lease, how with this have changed your depreciation calculation for Woods?
Explanation / Answer
a) Nature of the lease to Woods.
It is a capital lease for the following reasons:
c) Nature of the lease to Palmer.
It is capital lease for the following reasons:
As the fair value of the equipment of $200000 exceeds the lessor’s cost of $150000, the lease is sales-type lease.
Working Notes:
Annual rental payments: (using 11%)
200000-(10000*0.53464)/4.69590 = $46959
PV of Lease rent:(using 12%)
46959*4.60478 = 216236
b) Journal entries:
1/1/11
Leased Equipment (Dr) 216236
Liability for lease (Cr) 216236
(for recording the lease)
Liability for lease (Dr) 46959
Cash (Cr) 46959
(first lease rent payment)
12/31/11
Depreciation Expense (Dr) 36039
Accumulated Depn –capital leases (Cr) 36309
(to record depreciation)
Interest expense (Dr) 25948
Interest payable (Cr) 25948
(to record accrued interest)
1/1/12
Interest payable (Dr) 25948
Interest expense (Cr) 25948
(for reversing the accrual)
Interest Expense (Dr) 25948
Liability for lease (Dr) 21011
Cash (Cr) 46959
(Payment of lease rent)
d) It would be still a capital lease, but a direct-financing lease. No sale and no profit.
e)
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