Option #2: New Revenue Recognition Accounting Standards Homework Problems

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Leases--Critical Thinking Assignment Option #1

(Note: you can place your answers directly on this Word document and submit the completed Word document for grading, or you can prepare and submit your answers in an Excel file, using the Tab function to separate the answers for each of the Questions below, and submit just an Excel file for grading).

1. Lessee enters into a five-year lease of office space on January 1, and concludes that the agreement is an operating lease. Lessee pays initial direct costs of $5,000. The agreement provides the following:

Lease term	Five years, with the first payment due at lease commencement and the remainder annually at the lease anniversary date thereafter
Annual payments, beginning at lease commencement and annually thereafter	Commencement – $25,000 Year 2 – $26,000 Year 3 – $27,000 Year 4 -- $28,000 Year 5 -- $29,000
Discount rate	4.0%
Present value (PV) of lease payments	$124,645

Complete the following table to show the impact on each year of Lessee’s income statement and balance sheet. Prepare the journal entries for the Lessee at the commencement of the lease and at the end of year 1.

	Initial	Year 1	Year 2	Year 3	Year 4	Year 5
Cash lease payments
Income statement:
Periodic lease expense (straight-line)
Prepaid (accrued) rent for period
Balance sheet at end of year:
Lease liability
ROU asset:
Lease liability
Adjust: Accrued rent (cumulative)
Unamortized direct initial costs
ROU asset

2. Lessee enters into a four-year lease of equipment and concludes that the agreement is a finance lease because the lease contains an option for Lessee to purchase the equipment at the end of the lease and the Lessee is reasonably certain to exercise that option. The arrangement provides the following:

Lease term	Four years, with the first payment due at lease commencement and the remainder annually at the lease anniversary date thereafter
Annual payments, beginning at lease commencement and annually thereafter	Commencement – $50,000 Year 2 – $53,000 Year 3 – $55,000 Year 4 -- $60,000
Discount rate	4.5%
PV of lease payments	$204,577

Complete the following schedule to show the impact on the income statement and balance sheet.

	Initial	Year 1	Year 2	Year 3	Year 4
Cash lease payments
Income statement:
Lease expense recognized:
Interest expense
Amortization expense
Total periodic expense
Balance sheet:
ROU asset
Lease liability

· Prepare the journal entries at the time of the lease commencement and for Year 1 of the lease term.

3. Lessor enters into a seven-year lease for equipment with Lessee. Lessor sells and leases the equipment, which is not specialized in nature and is expected to have an alternative use for Lessor at the end of the lease term. Under the lease:

· Lessor receives annual lease payments of $25,000, with the first one payable at the commencement of the lease and one payment annually at the lease anniversary date thereafter.

· Lessor expects the residual value of the equipment to be $75,000 at the end of the lease term.

· Lessee provides an RVG that protects Lessor for the first $35,000 of loss below the estimated residual value at the end of the lease term of $75,000.

· The equipment has an estimated remaining economic life of nine years, a carrying amount of $150,000 and a fair value of $160,000.

· Lessor incurred costs of $3,000 for a broker’s commission as a result of obtaining the lease. These costs qualify as initial direct costs.

· The lease does not transfer ownership of the underlying asset to Lessee at the end of the lease term or contain an option for Lessee to purchase the equipment.

At lease commencement, Lessor concludes that it is probable that it will collect the lease payments and any amount probable of being owed under the RVG provided by Lessee.

· How should Lessor classify this lease?

· Prepare the journal entries at the time of the lease commencement and for Years 1 and 2 of the lease term.

4. Lessor enters into a four-year lease of equipment with Lessee. Lessor sells and leases the equipment, which is not specialized in nature and is expected to have an alternative use to Lessor at the end of the four-year lease term. Under the lease:

· Lessor receives annual lease payments of $30,000, payable at lease commencement and annually at the lease anniversary date thereafter.

· Lessor expects the residual value of the equipment to be $100,000 at the end of the five-year lease term.

· Lessee does not provide an RVG.

· The equipment has an estimated remaining economic life of 12 years, a carrying amount of $160,000 and a fair value of $170,000.

· Lessor incurred costs of $2,000 for a broker’s commission as a result of obtaining the lease. These costs qualify as initial direct costs and are capitalized when the lease is obtained.

· The lease does not transfer ownership of the underlying asset to Lessee at the end of the lease term or contain an option for Lessee to purchase the equipment.

At lease commencement, Lessor concludes that it is probable that it will collect the lease payments.

· How should Lessor classify this lease?

· Prepare the journal entries at the time of the lease commencement and for Years 1 and 2 of the lease term.