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Cleveland Inc. leased a new crane to Abriendo Construction
under a 5-year noncancelable contract starting January 1, 2014.
Terms of the lease require payments of
$33,000 each January 1, starting January 1, 2014. Cleveland will
pay insurance, taxes, and maintenance
charges on the crane, which has an estimated life of 12 years, a
fair value of $240,000, and a cost to Cleveland
of $240,000. The estimated fair value of the crane is expected to
be $45,000 at the end of the lease term.
No bargain-purchase or renewal options are included in the
contract. Both Cleveland and Abriendo adjust
and close books annually at December 31. Collectibility of the
lease payments is reasonably certain, and no
uncertainties exist relative to unreimbursable lessor costs.
Abriendo’s incremental borrowing rate is 10%,
and Cleveland’s implicit interest rate of 9% is known to Abriendo.
(a)Identify the type of lease involved and give reasons for your classification.
Discuss the accounting
treatment that should be applied by both the lessee and the
(b)Prepare all the entries related to the lease contract and leased
asset for the year 2014 for the lessee
and lessor, assuming the following amounts.
(4)Straight-line depreciation and salvage value $15,000.
(c)Discuss what should be presented in the balance sheet, the income
statement, and the related notes
both the lessee and the lessor at December 31, 2014.
The following facts pertain to a noncancelable lease agreement
between Faldo Leasing Company and Vance Company, a lessee.
Inception date January 1, 2014
Annual lease payment due at the beginning of
each year, beginning with January 1, 2014 $124,798
Residual value of equipment at end of lease term,
guaranteed by the lessee $50,000
Lease term 6 years
Economic life of leased equipment 6 years
Fair value of asset at January 1, 2014 $600,000
Lessor’s implicit rate 12%
Lessee’s incremental borrowing rate 12%
The lessee assumes responsibility for all executory costs, which
are expected to amount to $5,000 per year.
The asset will revert to the lessor at the end of the lease term.
The lessee has guaranteed the lessor a residual
value of $50,000. The lessee uses the straight-line depreciation
method for all equipment.
(a)Prepare an amortization schedule that would be suitable for the
lessee for the lease term.
(b)Prepare all of the journal entries for the lessee for 2014 and
2015 to record the lease agreement, the
lease payments, and all expenses related to this lease. Assume the
lessee’s annual accounting period
on December 31 and reversing entries are used when appropriate.
You are auditing the December 31, 2014, financial statements
of Hockney, Inc., manufacturer of novelties and party favors.
During your inspection of the company
garage, you discovered that a used automobile not listed in the
equipment subsidiary ledger is parked
there. You ask Stacy Reeder, plant manager, about the vehicle, and
she tells you that the company did not
list the automobile because the company was only leasing it. The
lease agreement was entered into on
January 1, 2014, with Crown New and Used Cars.
You decide to review the lease agreement to ensure that the lease
should be afforded operating lease
treatment, and you discover the following lease terms.
1.Noncancelable term of 4 years.
2.Rental of $3,240 per year (at the end of each year). (The present value
at 8% per year is $10,731.)
3.Estimated residual value after 4 years is $1,100. (The present
value at 8% per year is $809.) Hockney
guarantees the residual value of $1,100.
4.Estimated economic life of the automobile is 5 years.
5.Hockney’s incremental borrowing rate is 8% per year.
You are a senior auditor writing a memo to your supervisor, the
audit partner in charge of this audit, to
discuss the above situation. Be sure to include (a) why you
inspected the lease agreement, (b) what you
determined about the lease, and (c) how you advised your client to
account for this lease. Explain every
journal entry that you believe is necessary to record this lease
properly on the client’s books. (It is also
to include the fact that you communicated this information to your client.)