Assume the same data as in P20–13 and that Provincial Airlines Corp. has an incremental borrowing rate of 8%

Assume the same data as in P20–13 and that Provincial Airlines Corp. has an incremental borrowing rate of 8%.

Instructions

Answer the following questions, rounding all numbers to the nearest dollar.

(a) Discuss the nature of this lease in relation to the lessee.

(b) What classification will Provincial Airlines Corp. give to the lease?

(c) What difference, if any, would occur in the classification of the lease if Provincial were using IFRS?

(d) Using time value of money tables, a financial calculator, or computer spreadsheet functions, calculate the amount of

the initial obligation under capital leases.

(e) Prepare a 10-year lease amortization schedule for the lease obligation using a computer spreadsheet.

(f) Prepare all of the lessee’s journal entries for the first year, assuming that the lease year and Provincial Airlines’ fiscal year are the same.

(g) Prepare the entries in (f) again, assuming that the residual value of $15,000 was guaranteed by the lessee.

(h) Prepare the entries in (f) again, assuming a residual value at the end of the lease term of $45,000 and a purchase option of $15,000.

(a) For the lessee under PE GAAP, rather than using quantitative factors described under part (b) below for IFRS, quantitative criteria such as:

1. the term of the lease exceeding 75% of the remaining economic life of the asset,

2. the present value of the minimum lease payments exceeding 90% of the fair value of the asset, or

3. the presence of a bargain purchase option will be applied as the basis for the classification of the lease.

(b) It will be classified as a direct financing lease for Provincial Airlines Corp. because:

    (1) the lease term is 75% or more of the asset’s economic life and (2) the present value of the minimum lease payments exceeds 90% of the fair value of the leased asset.

(c)       The IFRS criteria use qualitative factors to establish whether or not the risks and rewards of ownership are transferred to the lessee, and supports classification as a finance lease:

1.  There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. If there is a bargain purchase option in the lease, it is assumed that the lessee will exercise it and obtain ownership of the asset.

2.  The lease term is long enough that the lessee will receive substantially all of the economic benefits that are expected to be derived from using the leased property over its life.

3.  The lease allows the lessor to recover substantially all of its investment in the leased property and to earn a return on the investment. Evidence of this is provided if the present value of the minimum lease payments is close to the fair value of the leased asset.

4.  The leased assets are so specialized that, without major modification, they are of use only to the lessee.

The lease would be classified as a finance lease.

(d) Initial Obligation Under Capital Leases:

    Minimum lease payments ($25,000) X PV of an

      annuity due for 10 periods at 8% (7.24689)  $181,172

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV	$   ?	Yields $181,172
I	8%
N	10
PMT	$  (25,000)
FV	$   0
Type	1

 (e)        Provincial Airlines Corp. (Lessee)

               Lease Amortization Schedule

               (Annuity due basis and URV)

                                                      

Beginning of Year			Annual Lease Payment		Interest (8%) on Unpaid Obligation		Reduction of Lease Obligation		Lease Obligation
Initial PV 1 2 3 4 5 6 7 8 9 10		(a) — $25,000  25,000  25,000  25,000  25,000  25,000  25,000  25,000  25,000  25,000 $250,000			(b) — — *$12,494* * 11,493* * 10,413* * 9,246* * 7,985* *  6,624* *  5,154* *  3,566* *  1,853* *$68,828*		(c) — $ 25,000   12,506   13,507   14,589   15,754   17,015   18,376   19,846   21,434   23,147 $181,172		(d) $181,172  156,172  143,666  130,159  115,572  99,818   82,803   64,427   44,581   23,147        0

    *Rounding error is $1.

    (a) Annual lease payment required by lease contract.

    (b) Preceding balance of (d) X 8%, except beginning of first year of lease term.

    (c) (a) minus (b).

    (d) Preceding balance minus (c).

 (f) Lessee’s journal entries:

                  Beginning of the Year

Leased Equipment......................   181,172

    Lease Obligation..................             181,172

      (To record the lease of equipment

       using capital lease method)

Lease Obligation......................    25,000

    Cash..............................              25,000

      (To record the first rental payment)

End of the Year

Interest Expense......................    12,494

    Interest Payable..................              12,494

      (To record accrual of annual interest on

           lease obligation)

Depreciation Expense..................    18,117

    Accumulated Depreciation—Leased

      Equipment.......................              18,117

      (To record depreciation expense for

       first year [$181,172 ÷ 10])

(g) Refer to the calculations and table of P20-13 for the amounts using the guaranteed residual value in the calculations of payments made by the lessee Provincial Airlines Corp.

                  Beginning of the Year

Leased Equipment......................   188,120

    Lease Obligation..................             188,120

      (To record the lease of equipment

       using capital lease method)

Lease Obligation......................    25,000

    Cash..............................              25,000

      (To record the first rental payment)

End of the Year

Interest Expense......................    13,050

    Interest Payable..................              13,050

      (To record accrual of annual interest on

           lease obligation)

Depreciation Expense..................    17,312

    Accumulated Depreciation—Leased

      Equipment.......................              17,312

      (To record depreciation expense for

       first year [$188,120 - $15,000 ÷ 10])

(h)  The residual value of $45,000 will not be included in calculation of the present value of the minimum lease payments. Rather, the bargain purchase option of $15,000 will be the future outflow in the calculations below. The bargain purchase option will permit depreciation of the equipment over its economic life of 12 years.

Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV	$   ?	Yields $188,120
I	8%
N	10
PMT	$ (25,000)
FV	$ (15,000)
Type	1

                  Beginning of the Year

Leased Equipment......................   188,120

    Lease Obligation..................             188,120

      (To record the lease of

       equipment using capital lease method)

Lease Obligation......................    25,000

    Cash..............................              25,000

      (To record the first rental payment)

End of the Year

Interest Expense......................    13,050

    Interest Payable..................              13,050

      (To record accrual of annual interest on

           lease obligation)

    [($188,120 - $25,000) X 8%]

Depreciation Expense..................    15,677

    Accumulated Depreciation—Leased

      Equipment.......................              15,677

      (To record depreciation expense for

       first year [$188,120 ÷ 12])