On September 15, 2011, Local Camping Products Limited, the lessee, entered into a 20-year lease with Sullivan Corp. to rent a parcel of land at a rate of $30,000 per year. Both Local and Sullivan use private enterprise GAAP. The annual rental is due in advance each September 15, beginning in 2011. The land has a current fair value of $195,000. The land reverts to Sullivan at the end of the lease. Local Camping’s incremental borrowing rate and Sullivan’s implicit interest rate are both 8%.
Instructions
(a) Prepare Local Camping Products’ required journal entries on September 15, 2011, and at December 31, 2011, its year end.
(b) Explain how and why these entries might differ if Local were leasing equipment instead of land.
(c) Prepare the entries required on Sullivan’s books at September 15, 2011, and at December 31, 2011, its year end.
(a)
September 15, 2011
Prepaid Land Rental..................... 30,000
Cash................................ 30,000
December 31, 2011
Land Rent Expense....................... 8,750
Prepaid Land Rental................. 8,750
($30,000 X 3.5 / 12) = $8,750
(b) The rental of land can only be accounted for as a capital lease by the lessee if the rental of the property contains a bargain purchase option or if the lease transfers ownership of the property to the lessee. Since this is not the case, here the lease of the land had to be treated as an operating lease. In the case of equipment the possibility of accounting for the lease as a capital lease is more likely depending on the terms of the lease in relation to the capitalization criteria.
(c)
September 15, 2011
Cash.................................... 30,000
Unearned Land Rental Income......... 30,000
December 31, 2011
Unearned Land Rental Income............. 8,750
Land Rental Income.................. 8,750
($30,000 X 3.5 / 12) = $8,750
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