Option #2: New Revenue Recognition Accounting Standards Homework Problems
Lotte101611
ACT580_OPT1A.docx
Leases
(Instructors: Note: Please do not distribute actual solutions attached to students, as it would potentially hurt relationship with Ernst & Young, which has been kind enough to allow us to use these problems in our course).
1.
|
1. |
Initiation |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
Cash lease payments |
$25,000 |
|
$26,000 |
$27,000 |
$28,000 |
$29,000 |
|
Income statement: |
|
|
|
|
|
|
|
Periodic lease expense (straight-line) |
|
27,000 |
27,000 |
27,000 |
27,000 |
27,000 |
|
Prepaid (accrued) rent for period |
$25,000 |
($27,000) |
($1,000) |
|
$1,000 |
$2,000 |
|
Balance sheet at end of year: |
|
|
|
|
|
|
|
Lease liability |
($124,645) |
($103,630) |
($80,735) |
($55,885) |
($29,000) |
$ |
|
|
|
|
|
|
|
|
|
ROU asset: |
|
|
|
|
|
|
|
Lease liability |
$124,645 |
$103,630 |
$80,735 |
$55,885 |
$29,000 |
$ |
|
Adjust: Prepaid (accrued) rent -- cumulative |
25,000 |
(2,000) |
(3,000) |
(3,000) |
(2,000) |
|
|
Unamortized direct initial costs |
5,000 |
4,000 |
3,000 |
2,000 |
1,000 |
|
|
ROU asset |
$154,645 |
$105,630 |
$80,735 |
$54,885 |
$28,000 |
$ |
|
|
|
|
|
|
|
|
|
At lease commencement |
|
|
|
|
|
|
|
ROU asset |
$154,645 |
|
|
|
|
|
|
Lease liability |
|
$124,645 |
|
|
|
|
|
Cash |
|
30,000 |
|
|
|
|
To recognize initial ROU asset and lease liability and to reflect payment of first lease payment and initial direct costs.
|
Year 1 journal entries |
|
|
|
|
|
|
|
Lease expense |
$28,000 |
|
|
|
|
|
|
ROU asset |
|
$28,000 |
|
|
|
|
|
Lease liability |
$21,015 |
|
|
|
|
|
|
ROU asset |
|
$21,015 |
|
|
|
|
To record lease expense (including amortization of initial direct costs) and adjust the ROU asset for the difference between the cash paid and straight-line lease expense and to adjust the lease liability to the PV of the remaining lease payments with an offset to the ROU asset (the adjustment of $21,015 is calculated as the initially recognized lease liability ($124,645) less the PV of the remaining lease payments ($103,630) at the end of year 1).
2.
|
|
Initial |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
|
Cash lease payments |
$50,000 |
|
$53,000 |
$56,000 |
$60,000 |
|
Income statement: |
|
|
|
|
|
|
Lease expense recognized: |
|
|
|
|
|
|
Interest expense |
|
$ 6,956 |
$ 4,884 |
$ 2,583 |
|
|
Amortization expense |
|
51,144 |
51,144 |
51,144 |
$51,145 |
|
Total periodic expense |
|
$58,100 |
$56,028 |
$53,727 |
$51,145 |
|
Balance sheet: |
|
|
|
|
|
|
ROU asset |
$204,577 |
$153,433 |
$102,289 |
$51,145 |
|
|
Lease liability |
($154,577) |
($161,533) |
($113,417) |
($60,000) |
|
|
At lease commencement |
|
|
|
ROU asset |
$204,577 |
|
|
Lease liability |
|
$50,000 |
|
Cash |
|
154,577 |
This recognizes the initial ROU asset and lease liability and reflects the first payment of $50,000.
|
Year 1 journal entries |
|
|
|
Interest expense |
$6,956 |
|
|
Lease liability |
|
$6,956 |
This records interest expense and accretes the lease liability using the interest method ($154,577 x 4.5%).
|
Amortization expense |
$23,000 |
|
|
Right-to-use asset |
|
$23,000 |
|
|
|
|
This records amortization expense on the right-to-use asset ($204,577/4).
3. Lessor classifies the lease as a sales-type lease because the lease term is a major part of the remaining economic life of the asset. While there is no bright-line test under ASC 842, 77% is more than the 75% threshold that Lessor uses in the lease classification test.
Lease commencement
First, we determine the implicit rate using the PV of an annuity due as follows:
|
|
N |
I/Y |
PV |
Cash receipt |
FV |
|
Given |
7 |
|
$160,000 |
$25,000 |
$75,000 |
|
Solve for the implicit rate |
12.3434% |
The lease amortization table is as follows:
|
Year |
Cash receipt |
Interest |
Principal |
Balance |
|
Initial net investment* |
|
|
|
$135,000 |
|
1 |
|
$16,664 |
($16,664) |
151,664 |
|
2 |
$25,000 |
15,635 |
9,365 |
142,299 |
|
3 |
25,000 |
14,479 |
10,521 |
131,778 |
|
4 |
25,000 |
13,180 |
11,820 |
119,958 |
|
5 |
25,000 |
11,721 |
13,279 |
106,679 |
|
6 |
25,000 |
10,081 |
14,919 |
91,760 |
|
7 |
25,000 |
8,240 |
16,760 |
75,000 |
*The initial net investment of $135,000 is calculated as the initial fair value of $160,000 less the initial cash receipt of $25,000.
At lease commencement
To record the net investment in the sales-type lease and derecognize the underlying asset and record the payment of initial direct costs and the receipt of lease payments for the first year:
|
Net investment in the lease (a) |
$135,000 |
|
|
Cash |
25,000 |
|
|
Cost of goods sold (b) |
132,290 |
|
|
Broker’s commission expense (c) |
3,000 |
|
|
Revenue (d) |
|
$142,290 |
|
Property held for lease (e) |
|
150,000 |
|
Cash (f) |
|
3,000 |
(a) The net investment in the lease consists of (1) the present value of the 7 annual lease payments of $25,000, less the first lease payment of $25,000 paid at lease commencement, plus the present value of the guaranteed residual value of $35,000, both discounted at the rate implicit in the lease, which equals $117,290 (i.e., the lease receivable) and (2) the present value of unguaranteed residual asset of $40,000, which equals $17,710. Note that the net investment in the lease is subject to the same considerations as other assets when classifying its components as current or noncurrent assets in a classified balance sheet.
(b) Cost of goods sold is the carrying amount of the equipment of $150,000 less the present value of the unguaranteed residual asset of $17,710.
(c) Costs incurred to pay a broker’s commission as a result of obtaining the lease are expensed at lease commencement.
(d) Revenue is the lower of the lease receivable ($142,290) and fair value ($160,000).
(e) $150,000 is the carrying amount of the underlying asset.
(f) Assumes Lessor is paying cash for the initial direct costs on the lease commencement date.
At lease commencement, Lessor recognizes selling profit of $10,000, which is calculated as the lease receivable of $142,290 less the carrying amount of the asset of $150,000, net of any unguaranteed residual asset of $17,710.
Year 1 journal entry for the sales-type lease (based on amortization table):
|
Net investment in the lease |
$16,664 |
|
|
Interest revenue |
|
16,664 |
This records the first year of interest revenue.
Year 2 journal entry for the sales-type lease (based on amortization table):
|
Cash |
$25,000 |
|
|
Net investment in the lease |
|
$ 9,365 |
|
Interest revenue |
|
15,635 |
This records the lease payment and interest revenue.
4. Lessor classifies the lease as an operating lease because none of the criterion for a sales-type lease are met and the PV of the sum of the lease payments by Lessee (there is no RVG from either the Lessee or another third party) does not exceed substantially all of the fair value of the underlying asset, so it does not qualify as a direct financing lease. The implicit rate on the lease is 10.7775% and the PV of lease payments totals $93,517 equaling 55% of the FV.
Lessor accounts for the operating lease by recognizing the lease payment of $30,000 per year on a straight-line basis after determining that another systematic and rational basis does not better represent the pattern in which benefit is expected to be derived from the use of the underlying asset. Lessor defers the initial direct costs (the broker’s commission) at lease commencement and amortizes them over the lease term on the same basis as lease income (straight-line basis over the four-year lease term).
Lease commencement
|
Deferred IDC |
$2,000 |
|
|
Cash |
|
$2,000 |
Year 1
|
Cash |
$30,000 |
|
|
Lease revenue |
|
$30,000 |
|
Expense |
$500 |
|
|
Deferred IDC |
|
500 |
Year 2
|
Cash |
$30,000 |
|
|
Lease revenue |
|
$30,000 |
|
Expense |
$500 |
|
|
Deferred IDC |
|
$500 |
2
Leases, ASC 842 – homework problem solutions 7
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