ACCT3103 - Intermediate Financial Accounting II

Assignment 3

Question 1 (Lease with bargain purchase option; lessee):

The following facts pertain to a non-cancelable lease agreement between Gold Leasing Company
and Solar Company, a lessee.
Inception date: January 1, 2021
The payments are to be made in advance on December
31 of each year except for the first one $12,000
Bargain-purchase option price at the end of lease term $40,000
Lease term 4 years
Economic life of leased equipment 6 years
Lessee’s incremental borrowing rate 7%
Lessor’s implicit rate Unknown
Residual value at the end of lease term $0

Required:
1. Prepare the journal entries to record the lease at the beginning of the lease term for the lessee.
2. Prepare all entries required on the books of Solar Company to record the lease on December
31, 2021, assuming Solar Company uses straight-line depreciation for all long-term assets.
Question 2 (Lease with a guaranteed residual value):
Silver Leasing agrees to lease equipment to A&B Furniture on January 1, 2022. The following
information relates to the lease agreement.

1. The term of the lease is 5 years with no renewal option, and the machinery has an
estimated economic life of 5 years.
2. The cost of the machinery is $700,000. The fair value of the asset on January 1, 2022 is
$700,000.
3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual
value of $75,000. The expected residual value would be $25,000 at the end of the lease
term. A&B uses straight-line depreciation for all long-term assets.
4. Silver’s implicit rate is 5%, and A&B’s incremental borrowing rate is 5%.

Required:
1. Calculate the amount of the annual rental payment required (assuming payments are to be
made in advance).
2. Prepare the journal entries to record the lease for A&B (the lessee) for the year 2022.
3. Prepare the journal entries to record the lease for Silver (the lessor) for the year 2022.
Question 3 (Lease with initial direct costs – from lessor’s perspective)
On January 1, 2021, Copper Leasing Company leased equipment to Crystal Corporation for a
5-year period ending December 31, 2025, at which time possession of the leased equipment will
revert back to Copper Leasing Company. The lease is noncancelable. The lease terms do not
provide for transfer of legal title, do not contain a bargain purchase option, and do not require the
lessee to guarantee a residual value. Initial direct costs of negotiating and consummating the
completed lease transaction incurred by Copper Leasing Company on January 1, 2021 were
$10,000. The equipment, which has expected useful life of 5 years and expected residual value
of $20,000, cost Copper Leasing Company $250,000 to manufacture. Its normal sales price was
$320,000 on January 1, 2021. Equal payments under the lease are $68,320 and are due on
January 1 of each year. The first payment was made on January 1, 2021. Collectibility of the
remaining lease payments is reasonably assured, and Copper Leasing Company has no material
cost uncertainties. Crystal’s incremental borrowing rate is 7%. Crystal knows that the interest
rate implicit in the leasing payments is 6%. Both companies use straight-line depreciation.

Required:
1. What is the nature of this lease to Copper Leasing Company (the lessor)? Explain.
2. Prepare the appropriate entries for Copper Leasing Company (the lessor) to record the lease and
the lease payment at its inception. Show calculations.
3. Determine the total amount of lease-related income Copper Leasing Company (the lessor) will
report for the year 2021.