4· value 10.00 points The City of Rochester signed a 30-year agreement with East

Question

4· value 10.00 points The City of Rochester signed a 30-year agreement with East Coast Real Estate, Inc. to lease a newly- constructed building for city services. The city agrees to make an initial payment of $2,600,000 and annual payments of $781,040 for the next 29 years. Using an assumed borrowing rate of 8 percent, the present value of the lease payments is approximately $11,315,200. At the time the lease agreement is signed, the building had an appraised market value of $12 million and an estimated life of 40 years Required a-1. Should the city consider this agreement a capital lease? O Yes No a-2. Complete the following criteria's in relation to decision making (Do not round, intermediate calculations. Round your answers to 1 decimal place.) 1 Present value of minimum lease payment as a percentage of fair value 2 Lease term as a percentage of estimated useful life of building b. Provide journal entries the city should make for both the capital projects fund and govenmental

Explanation / Answer

Answer a1)

For the agreement to be considered as Capital Lease any of the following four conditions need to be met:

1) Life of lease must be 75% or greater of the assets useful life.

Lease term as a percentage of estimated useful life of the building = Lease term / Life of the builidng = 30 / 40 = 75%

2) Lease must contain a bargain purchase option for a price less than market value.

3) Lessee must gain ownership at then end of the lease period

4) Present value of lease payments must be greater than 90% of the assets market value

PV of lease payments / Market value = 11315200 / 12000000 = 94,29%

Hence it meets the 1st and 4th condition, this can be considered as a capital lease

Answer a2)

From above calculation

Present value of minimum lease payment as a percentage of fair value of building = PV of lease payments / Market value = 11315200 / 12000000 = 94,29%

Lease term as a percentage of estimated useful life of the building = Lease term / Life of the builidng = 30 / 40 = 75%

Answer b)

Answer c)

The building will be included in the Statement of Net Assets as a capital asset and the long-term liabilities i.e the capital lease obligations are reported in the governmental activities column of the Statement of Net Assets.  

Hence it will be shown in Govenrment wide statement of net position

Transaction Fund General Journal Debit Credit 1 Capital Projects Fund Expenditures 11315200 Other Financing Sources - Capital Lease Agreements 11315200 (Being building acquired on capital lease) 2 Governmental Activities Building 11315200 Capital Lease Obligations Payable 11315200 (Being lease obligations payable for building acquired on lease for a period of 30 years)

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