David Tennant Industries Inc leases TARDIS equipment from Matt Smith Equipment C

Question

David Tennant Industries Inc leases TARDIS equipment from Matt Smith Equipment Corp for five years on 1/1/18 at $25,000 per year. The equipment has a five year economic life. Lease payments are due on 12/31of each year(not on 1/1 of each year). David Tennant Industries does not know Matt’s Smith’s implicit interest rate but their incremental borrowing rate is 5%. The lease conveys no transfer of ownership at the end of the term. There is no purchase option and no guarantee of residual value. Similar assets are depreciated on a straight line basis.

David Tennant Industries also leases a sonic screwdriver from Song Industrial for three years starting 1/1/18. The machine has a fair value of $75,000, a 100 year economic life, and Song Industrial has other uses for it after the lease term. The lease calls for payment of $10,000 a year due on 12/31 of each year. The implicit rate is known and is 5%. The lease conveys no transfer of ownership at the end of the term. There is no purchase option and no guarantee of residual value

·Prepare a schedule of items and their values which will appear on the balance sheet as of 12/31/19

·Prepare a schedule of items and their values which will appear on the income statement for the year ended 12/31/19

·Prepare a schedule of items and their values which will appear on the statement of cash flows for the year ended 12/31/19 (assuming the indirect method)

Explanation / Answer

1. Tardis equipment As the lease term is(100%) formore than 75% of the useful economic life of the asset, this isaccounted as a CAPITAL lease in the books of David TennantIndustries Inc. 2. Song Industrial sonicscrewdriver The lease conveys no transferof ownership at the end of the term. No purchase option and noguarantee of residual value Lease term does not measureupto 75% of the useful economic life of the asset Present Value of the 3 minimumYear-end payments of $ 10000 at the implicit rate of 5%is- 10000*(1-1.05^-3)/0.05= $ 27232 which is much less than90% of the fair value of $ 75000 (67500) So, this is not a capitallease but to be accounted as anOPERATING lease. TardisEquipment--Capital Lease At inception of the lease 1/1/2018 Leased Equipment 108237 Capital Lease liability 108237 25000*(1-1.05^-5)/0.05 12/31/2018 Depreciation expense 21647 Accumulated Depn.-Leased equipment 21647 (108237/5) Interest expense(108237*5%) 5412 Capital Lease liability(25000-5412) 19588 Cash 25000 1/1/2019 NO ENTRY 12/31/2019 Depreciation expense 21647 Accumulated Depn.-Leased equipment 21647 (108237/5) Interest expense((108237-19588)*5%) 4432 Capital Lease liability(25000-5412) 20568 Cash 25000 Capital Leaseamortisation Year Annuity payment Tow. Int. Tow. Principal Prin. Bal. 0 108237 1 25000 5412 19588 88649 2 25000 4432 20568 68081 3 25000 3404 21596 46485 4 25000 2324 22676 23810 5 25000 1190 23810 0 Song Industrial---Operating Lease 1/1/2018 NO ENTRY 12/31/2018 Lease rental expense 10000 Cash 10000 1/1/2019 NO ENTRY 12/31/2019 Lease rental expense 10000 Cash 10000 2. Balance sheetitems For 12/31 /2019 Assets Leased Equipment 108237 Less: Accumulated depreciation 43295 Equipment,net 64942 Liabilities Long-term liabilities Capital lease liability for leasedequipment 68081 3. Income Statement For the Yr. ended 12/31/2019 Depreciation expense 21647 Interest expense 4432 Lease rentals 10000 4. Cash flow statement (partial) Operating activities: Net Income as per Income statement Add: Non-cash charges Depreciation expense 21647 Investing activities Financing activities Installment tow.lease liability -20568

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