910 SECTION 3 Financial Instruments and Liabilities Branif Leasing leases mechanical equipment to industrial consumers under direct financing leases that earn Branif a 10% rate of return for providing long-term financing. A lease agreement with Branson Construction specified 20 annual payments of $100,000 beginning December 31, 2016, the inception of the lease. The estimated useful life of the leased equipment is 20 years with no residual value. Its cost to Branif was $936,500. The lease qualifies as a capital lease to Branson. Maintenance of the equipment was contracted for through a 20-year service agreement with Midway Service Company requiring 20 annual payments of $3,000 beginning December 31, 2016. Both companies use straight-line depreciation. Required: Prepare the appropriate entries for both the lessee and lessor to record the second lease payment and depreciation on December 31, 2017, under each of three independent assumptions: 1. The lessee pays executory costs as incurred. 2. The contract specifies that the lessor pays executory costs as incurred. The lessee’s lease payments were increased to $103,000 to include an amount sufficient to reimburse these costs. 3. The contract specifies that the lessor pays executory costs as incurred. The lessee’s lease payments were increased to $103,300 to include an amount sufficient to reimburse these costs plus a 10% management fee for Branif. Mid-South Auto Leasing leases vehicles to consumers. The attraction to customers is that the company can offer competitive prices due to volume buying and requires an interest rate implicit in the lease that is one percent below alternate methods of financing. On September 30, 2016, the company leased a delivery truck to a local florist, Anything Grows. The lease agreement specified quarterly payments of $3,000 beginning September 30, 2016, the inception of the lease, and each quarter (December 31, March 31, and June 30) through June 30, 2019 (three-year lease term). The florist had the option to purchase the truck on September 29, 2018, for $6,000 when it was expected to have a residual value of $10,000. The estimated useful life of the truck is four years. Mid-South Auto Leasing’s quarterly interest rate for determining payments was 3% (approximately 12% annually). Mid-South paid $25,000 for the truck. Both companies use straight-line depreciation. Anything Grows’ incremental interest rate is 12%. Hint: A lease term ends for accounting purposes when an option becomes exercisable if it’s expected to be exercised (i.e., a BPO). Required: 1. Calculate the amount of dealer’s profit that Mid-South would recognize in this sales-type lease. (Be careful to note that, although payments occur on the last calendar day of each quarter, since the first payment was at the inception of the lease, payments represent an annuity due.) 2. Prepare the appropriate entries for Anything Grows and Mid-South on September 30, 2016. 3. Prepare an amortization schedule(s) describing the pattern of interest expense for Anything Grows and interest revenue for Mid-South Auto Leasing over the lease term. 4. Prepare the appropriate entries for Anything Grows and Mid-South Auto Leasing on December 31, 2016. 5. Prepare the appropriate entries for Anything Grows and Mid-South on September 29, 2018, assuming the bargain purchase option was exercised on that date. P 15–14 Executory costs; lessor and lessee ● LO15–3, LO15–5, LO15–9 P 15–15 Sales-type lease; bargain purchase option exercisable before lease term ends; lessor and lessee ● LO15–3, LO15–5, LO15–6, LO15–7, LO15–8 ✮ Situation 1 2 3 4 Lease term (years) 4 5 6 4 Lessor’s cost $369,175 $449,896 $500,000 $400,000 Asset’s useful life (years) 6 7 7 5 Lessor’s implicit rate (known by lessee) 10% 12% 9% 10% Lessee’s incremental borrowing rate 9% 10% 11% 12% Residual value: Guaranteed by lessee 0 $ 53,000 $ 40,000 $ 60,000 Guaranteed by third party* 0 0 0 $ 50,000 Unguaranteed $ 30,000 0 $ 35,000 $ 40,000 Executory costs paid annually by lessor $ 1,000 $ 8,000 $ 5,000 $ 10,000 *Over and above any amount guaranteed by the lessee (after a deductible equal to any amount guaranteed by the lessee).
Spiceland_Inter_Accounting8e_Ch15
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