Oakridge Leasing Corporation, which uses private enterprise GAAP, signs an agreement on January 1, 2011, to lease equipment to LeBlanc Limited. The following information relates to the agreement:
1. The term of the non-cancellable lease is five years, with no renewal option. The equipment has an estimated economic life of six years.
2. The asset’s fair value at January 1, 2011, is $80,000.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $7,000, which is not guaranteed.
4. LeBlanc Limited assumes direct responsibility for all executory costs, which include the following annual amounts: $900 to Rocky Mountain Insurance Corporation for insurance and $1,600 to James County for property taxes.
5. The agreement requires equal annual rental payments of $18,142.95 to the lessor, beginning on January 1, 2011.
6. The lessee’s incremental borrowing rate is 11%. The lessor’s implicit rate is 10% and is known to the lessee.
7. LeBlanc Limited uses the straight-line depreciation method for all equipment.
8. LeBlanc uses reversing entries when appropriate.
Instructions
Answer the following, rounding all numbers to the nearest cent.
(a) Use a computer spreadsheet to prepare an amortization schedule for LeBlanc Limited for the lease term.
(b) Prepare all of LeBlanc’s journal entries for 2011 and 2012 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume that the lessee’s annual accounting period ends on December 31.
(c) Provide the required note disclosure for LeBlanc Limited concerning the lease for the fiscal year ending December 31, 2012.
(d) Would this lease be considered a capital lease if the company reported under IFRS? Would the note disclosure required in (c) above need to be modified under IFRS?
This lease is a capital lease to the lessee because the lease term (five years) exceeds 75% of the economic life of the asset (six years). Also, the present value of the minimum lease payments exceeds 90% of the fair value of the asset.
$18,142.95 Annual rental payment
X 4.16986 PV of an annuity due of 1 for n = 5, i = 10%
$75,653.56 PV of minimum lease payments
| Excel formula =PV(rate,nper,pmt,fv,type) |
| Using a financial calculator: | ||
| PV | $ ? | Yields $75,654 |
| I | 10% | |
| N | 5 | |
| PMT | $ (18,142.95) | |
| FV | $ 0 | |
| Type | 1 | |
(a)
LeBlanc Limited (Lessee)
Lease Amortization Schedule
| Date | | Annual Lease Payment | | Interest (10%)[1] on Unpaid Obligation | | Reduction of Lease Obligation | | Balance of Lease Obligation |
| | | | | | | | | |
| 1/1/11 1/1/11 1/1/12 1/1/13 1/1/14 1/1/15 | | $18,142.95 18,142.95 18,142.95 18,142.95 18,142.95 $90,714.75 | | *$ 5,751.06* * 4,511.87* * 3,148.76* * 1,649.50* *$15,061.19* | | $18,142.95 12,391.89 13,631.08 14,994.19 16,493.45 $75,653.56 | | $75,653.56 57,510.61 45,118.72 31,487.64 16,493.45 0.00 |
*Rounding error is 15 cents.
(b)
1/1/11 Leased Equipment.............. 75,653.56
Lease Obligation........ 75,653.56
1/1/11 Lease Obligation.............. 18,142.95
Cash.................... 18,142.95
During 2011
Insurance Expense............. 900.00
Cash.................... 900.00
Property Tax Expense.......... 1,600.00
Cash.................... 1,600.00
12/31/11 Interest Expense........ 5,751.06
Interest Payable........ 5,751.06
Depreciation Expense.......... 15,130.71
Accumulated Depreciation
—Leased Equipment..... 15,130.71
($75,653.56 ÷ 5 = $15,130.71)
1/1/12 Interest Payable* ............ 5,751.06
Interest Expense........ 5,751.06
Interest Expense.............. 5,751.06
Lease Obligation.............. 12,391.89
Cash.................... 18,142.95
The use of reversing entries is optional
During 2012
Insurance Expense............. 900.00
Cash.................... 900.00
Property Tax Expense.......... 1,600.00
Cash.................... 1,600.00
12/31/12 Interest Expense........ 4,511.87
Interest Payable....... 4,511.87
Depreciation Expense......... 15,130.71
Accumulated Depreciation
—Leased Equipment.. 15,130.71
The lessor sets the annual rental payment as follows:
Fair market value of leased asset to lessor $80,000.00
Less: Present value of unguaranteed
residual value $7,000 X .62092
(present value of 1 at 10% for 5 periods) 4,346.44
Amount to be recovered through lease payments $75,653.56
Five periodic lease payments
$75,653.56 ÷ 4.16986* $18,142.95
*Present value of annuity due of 1 for 5 periods at 10%.
| Excel formula =PMT(rate,nper,pv,fv,type) |
| Using a financial calculator: | ||
| PV | $ (80,000) | |
| I | 10% | |
| N | 5 | |
| PMT | $ ? | Yields $18,142.92 |
| FV | $ 7,000 | |
| Type | 1 | |
(c) Note X:
The following is a schedule of future minimum lease payments under the capital lease expiring December 31, 2015 together with the balance of the obligation under capital lease.
Year ending December 31
2013 $18,143
2014 18,143
2015 18,143
Total minimum lease payments 54,429
Less amount representing interest at 10% 9,310
Balance of the obligation $45,119
(d) Rather than using quantitative factors such as the 75 percent and the 90 percent hurdles often referred to as the bright lines used in PE GAAP, 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.
None of the numerical thresholds need be applied, as was the case in PE GAAP, and so the treatment of the lease by the lessee would be the same, although it would be referred to as a finance lease, rather than a capital lease.
As for the note disclosure provided in part (c) above, additional disclosures would also be required about material lease arrangements including contingent rents, sub-lease payments and lease-imposed restrictions. These do not apply in this case.
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