On January 1, 2014, Garfield Corp. (lessor) entered into a noncancellable lease
ID: 2582978 • Letter: O
Question
On January 1, 2014, Garfield Corp. (lessor) entered into a noncancellable lease agreement with Odie Corp. (lessee) for machinery which was carried in Garfield’s accounting records at $2,265,000 and had a fair value of $2,400,000. Minimum lease payments under the lease agreement, which expires on December 31, 2023, total $3,550,000. Payments of $355,000 are due each January 1. The first payment was made on January 1, 2014 when the lease agreement was finalized. The interest rate of 10% which was stipulated in the lease agreement is the implicit rate set by the lessor. The effective interest method is being used. Odie expects the machine to have a ten-year life with no residual value, and be depreciated on a straight-line basis. Collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the costs yet to be incurred by Garfield. Both entities are small private corporations that follow ASPE.
Instructions
a. From the lessee's viewpoint, what kind of lease is the above agreement? From the lessor's viewpoint, what kind of lease is the above agreement?
b. Ignoring income taxes, what should be the income reported by Garfield from the lease for calendar 2014?
c. Ignoring income taxes, what should be the expenses incurred by Odie from this lease for the calendar 2014?
d. What journal entries should be recorded by Odie Corp. on January 1, 2014?
e. What journal entries should be recorded by Garfield Corp. on January 1, 2014
Explanation / Answer
a)
In the given case, the lease agreement is in the nature of finance lease from the prespective of both the companies, reason being,
The estimated useful life is around 10 years and the lease period is also around 10 years, hence, the asset is being ussed substianlly by the lesse, also, all the risks and rewards incidental to such asset is automatically to the lesse.
Also, the sum of the present value of the minimum lease payment is approximately equal to the fair value of the asset.
Hence, the said agreement is Finance Lease.
b)
Finance Income to be reported by Garfield in Calender 2014 shall be as follows:
Garfield shall record this transaction at Net Investment Value, which shall be equal to $ 24,00,000 (Gross Investment Value(GIL) - [(GIL)-Present Value of Minimum Lease payement(MLP)]
We calculate the present value of MLP at a rate of 10% as follows:
Total Income for Calender 2014 = ($ 355,000 - $355,000) + ($ 355,000 - $322,727) = $ 32273 shall be recognised as Finance Income.
C)
Expense incured by Odie :
Depreciation = $ 2,400,000 / 10 = $ 240,000
Finance Expense = $ 355,000 - $ 322,727 = $ 32,273.
Total = $ 272,273
d) i) Asset A/ c - Debit $ 2,400,000
TO Garfield Corp A/c $ 2,400,000
ii) Garfield Corp A/c - Debit $ 355,000
TO Bank A/c $ 355,000
e) Odie Corp A/c - debit $ 2,400,000
To Asset A/c $ 2,265,000
To Other Equity $ 135,000
Bank A/c - debit $ 355,000
To Odie Corp A/c $ 355,000
Note : No entry for recognising Finance income and expense has been passed as the entry is passed on 1st Jan, 2014 and there is no time gap, accordingly no period has elapsed.
Period Annual Lease Payement PV Factor Present Value 0 355000 1 355000 1 355000 0.9091 322727 2 355000 0.8264 293388 3 355000 0.7513 266717 4 355000 0.6830 242470 5 355000 0.6209 220427 6 355000 0.5645 200388 7 355000 0.5132 182171 8 355000 0.4665 165610 9 355000 0.4241 150555 Grand Total 2400000Related Questions
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