1-1-08, Kimberly-Clark Corp. signs 10-year, non-cancelable lease agreement to lease a storage building from Sheffield Storage Co. KC is LESSEE. Equal.

1-1-08, Kimberly-Clark Corp. signs 10-year, non-cancelable leaseagreement to lease a storage building from Sheffield Storage Co. KC is LESSEE.

• Equal rent payments of $72,000 starting 1/1/08• FMV of building 1-1-08 is $440,000.• Blding has economic life of 12 years, with Unguaranteed R.V. of $10,000. ST-LINE depreciation.• NON-renewable lease. Building reverts to lessor at termination

of lease (THUS NO BPO).• KC (LESSEE’S) incremental borrowing rate 12% annual.• LESSOR’S rate is unknown.• Yearly rent payment includes $2,470.51 of executory costs

related to taxes on property.

Instructions: Prepare journal entries on LESSEE’s BOOKSto reflect signing lease and payments/expenses for 08 and 09.Year end 12/31.

Expenses of ownership and use (e.g.,insurance, tax, maintenance).

How are they accounted for in an OPERATING LEASE?

Paid by lessor and recovered in periodic rent payments.

How are they accounted for in a capital lease?

LESSOR LESSEE

If lessor retains responsibilityfor payment

DON’T capitalize intoPV of minimum lease payments;

executory costs subtractedfrom lease payment beforePV min lease payments calculated

If paid directly by lessee tothe third party

No need to adjust the rent payment because it doesn’tinclude the executory costs.

How much then are the yearly rent payments?

Capitalized amount of the lease:Yearly payment $ 72,000.00Executory costs 2,470.51Minimum annual lease payment $69,529.49

What is the PRESENT VALUE of the minimum lease payments?

Present value of minimum lease payments$69,529.49 X 6.32825 = $440,000.00

10 years at 12%

What entry records the lease obligation for the LESSEE?

1/1/08 Leased Asset 440,000.00    Lease Liability 440,000.00

What entry records the first lease payment?

1/1/08 Executory Costs—Property Taxes 2,470.51Lease Liability 69,529.49

Cash 72,000.00

What other entries are needed for the LESSEE?

DEPRECIATION

12/31/05 Depreciation Expense 44,000.00   Accumulated Depreciation—

Capital Leases 44,000.00($440,000 ÷ 10)

INTERESTtable next slide.

* Don’t subtract salvage because its unguaranteed and no transfer of ownership.

Schedule 1 Kimberly-Clark Paper Co.Lease Amortization Schedule

(Lessee)

Annual Payment Reduction BalanceLess of Lease of Lease

Date Executory Costs Interest (12%) Obligation Obligation

1/1/08 $440,000.001/1/08 $69,529.49 -0-     $69,529.49 370,470.511/1/09 69,529.49 $44,456.46 25,073.03 345,397.481/1/10 69,529.49 41,447.70 28,081.79 317,315.69

INTEREST for 2008

12/31/08 Interest Expense …………….. 44,456.46accrued      Lease Liability (int/p) 44,456.46* payment made in cash on 1/1/09

Payment on 1/1/09

1/1/09 Executory Costs—Property Taxes 2,470.51Interest Payable (lease liab) 44,456.46Lease Liability 25,073.03

Cash 72,000.00

Other entries

12/31/09 Depreciation Expense 44,000.00   Accumulated Depreciation—

Capital Leases 44,000.00

12/31/09 Interest Expense 41,447.70     Lease Liability (int/p)….. 41,447.70

Castle Leasing Co. signs lease on 1-1-08 to lease electronicequipment to Jan Way Co.

• 2 year lease• Payments at END of year.• BPO for $16,000 at termination of lease.• Cost/FMV of equipment is $160,000 to Castle.

• Economic life is 2 years.• Residual value is $16,000

• Executory costs of $5,000/yr paid by Jan Way (LESSEE)• Castle leasing desires 10% return.• Collectibility of payments reasonably predictable and no important uncertainties surround costs yet to be incurred.

a. Prepare entries for CASTLE (LESSOR) for 2008 and 2009

How much is the lease payment? LESSOR figures this out.

The formula:

PV of min lease = (Rent x factor) + (BPO x factor)

$160,000

FMV usually same thing

= (Rent x What Rate?)

RULE ON WHAT RATE TO USE FOR DISCOUNTING

LESSEE

Uses the lower of his/her rate or the lessors;To find leased asset.

LESSOR

Uses his/her own rate.

How much is the lease payment? LESSOR figures this out.

The formula:

PV of min lease = (Rent x factor) + (BPO x factor)

$160,000

FMV usually same thing

= (Rent x What Rate?)

Lessor wants to earn 10%

How much is the lease payment?

The formula:

PV of min lease = (Rent x factor) + (BPO x factor)

$160,000 = (Rent x 1.73554) + ($16,000 X .82645)

Table 6-4 (2 years @ 10%; ordinary annuity)

Table 6-2 (2 years @ 10%; lump sum)

How much is the lease payment?

The formula:

PV of min lease = (Rent x factor) + (BPO x factor)

$160,000 = (Rent x 1.73554) + ($16,000 X .82645)

Table 6-4 (2 years @ 10%; ordinary annuity)

Table 6-3 (2 years @ 10%; lump sum)

RENT = $84,571.26

How much is the balance of lease receivable?

$160,000 (same as PV of lease)

What does the interest table look like?

Castle Leasing Company (Lessor)Lease Amortization Schedule

Annual Payment Interest NetLease On Net Investment Net

Date Investment Recovery Investment

1/1/08 $160,000.0012/31/08 $84,571.26 $16,000.00 $68,571.26 91,428.7412/31/09 84,571.26 009,142.52* 75,428.74 16,000.00

$25,142.52

*Difference of $.35 due to rounding.

Entry on 1/1/08 to initiate lease LESSOR

(a) 1/1/08 Lease Payments Receivable 160,000Equipment 160,000.00

Entries on 12/31/08

To record lease receipt.

Cash ($84,571.26 + $5,000) 89,571.26Executory CostsPayable 5,000.00Lease Receivable 68,571.26Interest Revenue 16,000.00

12/31/09 Cash 89,571.26Executory Costs Payable 5,000.00Lease Payments Receivable 75,428.74Interest Revenue................ 9,142.52

B. If Jan Way uses BPO, what journal entry reflects the sale?

Cash…………….. $16,000Lease Payments Receivable…. $16,000

T-account analysis of Lease Receivable next slide.

Lease Receivable

$160,000 $68,571.26

$75,428.74

$16,000This is theBPO

Crosley Company, a machinery dealer, leased a machine to Dexter Corporationon January 1, 2007. The lease is for an 8-year period and requires equal annualpayments of $35,013 at the beginning of each year.

The first payment is received on January 1, 2007. Crosley had purchased themachine during 2006 for $160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amountof costs yet to be incurred by Crosley. Crosley set the annual rental to ensurean 11% rate of return. The machine has an economic life of 10 years withno residual value and reverts to Crosley at the termination of the lease.

(a) Compute the amount of the LEASE RECEIVABLE.

$35,013 X 5.7122 = $200,001

Entry to record the lease at its inception for Crosley

Lease payments receivable..... $200,001

Inventory (equipment)................ $160,000 (book)

Cost of goods sold.................... 160,000

Sales............................................ $200,001 (FMV)

(b) Prepare all necessary journal entries for Crosley for 2007.

Entry to record the first lease payment (receipt)

Cash.......... $35,013Lease payments receivable........ $35,013

Entry to record interest revenue adjustment.

($200,001 - $35,013) = $164,987 x .11= $18,148

Interest Receivable............. $18,148Interest revenue......................$18,148

Noncancellable lease between Mike Mooney Leasing (OR) and Denise Rode (EE).

•Inception (May 1, 2007)•Annual rent (Due at beginning of year starting 5/1/07); $21,227.65•BPO at EOL… $4,000.•Lease term 5 years•Economic life- 10 years•Lessor’s cost.. $65,000•FMV on 5/1/07… $91,000•Lessors ROR… 10%•Lessee’s ROR… 10%•Lessee assumes all executory costs.

A. Discuss the NATURE of this lease to RODE (LESSEE).

collectibility reasonably predictable.

no important uncertainties surrounding costsyet to be incurred by lessor.

lessee assumes responsibility for all executory costs

The lease agreement has a BPO and, thus meets the criteria to be classified asa capital lease from the viewpoint of the lessee. The present value of the minimum lease payments exceeds 90% of the FMV of the assets.

B. Discuss the nature of the lease to MOONEY Company (LESSOR).

The lease agreement has a BPO. The collectibility of the lease paymentsis reasonably predictable, and there are no important uncertainties surroundingthe costs yet to be incurred by the lessor. The lease, therefore, qualifies as a capital type lease from the viewpoint of the lessor. Due to the fact that the initialamount of net investment (which in this case equal the present value of theminimum lease payments, $91,000) exceeds the lessor’s cost of $65,000, the leaseis a SALES TYPE LEASE.

C. Prepare Lease Amortization schedule for RODE (LESEE).

Need the PV of the minimum lease payments.

Should be $91,000 (FMV of asset).

($21,227.65 x 4.16986) + ($4,000 x .62092) = $91,000

rent 10%, 5 yrsT 6-5 BPO

10%, 5 yrsT 6-2

Denise Rode Company (LESSEE)Lease Amortization Schedule

AnnualLease Reduction BalancePayment Interest (10%) on unpaid of lease

Date Plus BPO Obligation Obligation Obligation

5/1/07 $91,000

5/1/07 $21,227.65 $21,227.65 69,772.35

5/1/08 $21,227.65 $6,977.24 14,250.41 55,521.945/1/09 21,227.65 5,552.19 15,675.46 39,846.485/1/10 21,227.65 3,984.65 17,243.00 22,603.485/1/11 21,227.65 2,260.35 18,967.30 3,636.184/30/12 4,000.00 363.82 3,636.18 -0-

-------------- ------------ -------------$110,138.25 $19,138.25 $91,000

D. Prepare journal entries on the LESSEE’s books. Reversingentries ARE USED by RODES.

Entries needed on 5/1/07

Leased asset……….. $91,000Lease liability………$91,000

Lease liability…. $21,227.65Cash……………$21,227.65

Entries needed on 12/31/07

To record interest

Interest expense… $4,651.49Interest payable… $4,651.49

6977.24 x 8/12 = 4651.49

To record depreciation

Depreciation expense… $6,066.67Accumulated depreciation……. $6,066.67

$91,000 / 10 = $9,100.00

$9,100 x 8/12 = $6,066.67LIFE of assetbecause of BPO(no salvage is mentioned)

Entries on 1/1/08

Interest payable……. $4,651.49Interest expense……. $4,651.49 REVERSING

Entries for 5/1/08

Interest expense… $6977.24Lease Liability…. $14,250.41

Cash…………….$21,227.65

Entries for 12/31/08

Interest expense…….. $3701.46 (5552 x 8/12)Interest payable……..$3701.46

Depreciation Expense….. $9100Accumulated depreciation….$9100

Continuation of E 21-8

A. Compute the amount of Lease Receivable at the start of the lease.

($21,227.65 x 4.16986) + ($4,000 x .62092) = $91,000

B. Prepare the lease amortization schedule for MOONEY

AnnualLease Interest Net NetPayment (10%) on Investment Investment

Date Plus BPO Investment Recovery

5/1/07 $91,000

5/1/07 $21,227.65 $21,227.65 69,772.355/1/08 21,227.65 6,977.24 14,250.41 55,521.945/1/09 21,227.65 5,552.19 15,675.46 39,846.485/1/10 21,227.65 3,984.65 17,243.00 22,603.485/1/11 21,227.65 2,260.35 18,967.30 3,636.184/30/12 4,000.00 363.82 3,636.18 -0-

-------------- ----------- ---------------$110,138.25 $19,138.25 $91,000.00

D. Prepare journal entries for MOONEY. Reversing NOT used.

Record the signing of the lease.

Lease Receivable…. $91,000

Sales……. $91,000

COG………………. $65,000

Inventory.. $65,000

The first lease payment.

Cash……. $21,227.65Lease Receivable…. $21,227.65

12/31/07 Adjust the interest.

Interest Receivable....… $4,651.49Interest revenue……………..$4,651.49

$6,977.24 x 8/12 = $4,651.49

5/1/08 Receipt of cash payment.

Cash…….. $21,227.65Lease Receivable…… $14,250.41Interest Receivable.....$ 4,651.49Interest Revenue....... .$ 2325.72 ($6,977.21 - $4,651.49)

Adjustment of interest 12/31/08Interest Receivable… $3,701.46

Interest revenue………….$3,701.46

$5,552.19 x 8/12 = $3,701.46

Rest of the entries for 2009

5/1/09 Cash…… $21,227.65Lease receivable…….$15,675.46Interest Receivable....$ 3,701.46Interest Revenue........$ 1,850.73 (5,552.19 - $3,701.46)

12/31/09 Interest Receivable.......… $2,656.43Interest revenue…………$2,656.43

* 8/12 adjustment (3,984.65 x 8/12 ) = $2,656.43

Morgan Marie Leasing Co. signs an agreement on January 1, 2004 to leaseequipment to Cole William Company. The following information relates to this agreement.

1. The term of the noncancelable lease is 6 years with no renewal option.The equipment has an estimated economic life of 6 years.

2. The cost of the asset to the lessor is $245,000. The fair value of the asset at January 1, 2004 is $245,000.

3. The asset will revert to the lessor at the end of the lease term at whichtime the asset is expected to have a residual value of $43,622, noneof which is guaranteed.

4. Cole William Company assumes direct responsibility for all executorycosts. (LESSEE RESPONSIBLE).

5. The agreement requires equal annual rental payments, beginningon January 1, 2004.

6. Collectibility of the lease payments is reasonably predictable. There areno important uncertainties surrounding the amount of costs yet to beincurred by the lessor.

Instructions:

a. Assuming the lessor desires a 10% rate of return on its investment,calculate the amount of the annual rent payment.

FMV = (Rent x factor) + (Residual value x factor)

$245,000 4.790796 per @ 10%

$43,622 .56447

$46,000

B. Prepare an amortization schedule that would be suitable for the lessorfor the lease term.

Morgan Marie Leasing Company (Lessor)Lease Amortization Schedule

AnnualLease Interest Net Balance

Date Payment (10%) on Invest- of NetPlus URV Net Invest. ment Recovery Investment

1/1/04 $245,0001/1/04 $46,000 $46,000 199,0001/1/05 46,000 19,900 26,100 172,9001/1/06 46,000 17,290 28,710 144,1901/1/07 46,000 14,419 31,581 112,6091/1/08 46,000 11,261 34,739 77,8701/1/09 46,000 7,787 38,213 39,65712/31/09 43,622 3,965 39,657 0

------------ ---------- ------------- ------------------- $319,622 $ 74,622 $245,000

C. Prepare all of the journal entries for the LESSOR for 2004 and 2005.

To record inception of lease 1/1/04

Lease Receivable…………… $319,622Equipment……………………$245,000Unearned interest revenue…. 74,622

To record receipt of first cash payment on 1/1/04

Cash………………. $46,000Lease Receivable………… $46,000

To record accrual of interest on 12/31/04

Unearned interest revenue………. $19,900Interest revenue………………….$19,900

Receipt of second payment on 1/1/05

Cash…………….. $46,000Lease Receivable……….. $46,000

Accrual of interest on 12/31/05

Unearned interest revenue…… $17,290Interest revenue……………..$17,290