Accounting for Leases by Lessee and Lessor Scupper Farms, the lessee, and Tyrrel
ID: 2579506 • Letter: A
Question
Accounting for Leases by Lessee and Lessor Scupper Farms, the lessee, and Tyrrell Equipment, the lessor, sign a lease agreement on January 1, 2016, that provides for Scupper to lease a cultivator from Tyrrell. The lease terms, provisions, and other related events are as follows:
-The lease is noncancelable and has a term of 6 years
-The annual rentals are $56,100 (including executory costs), payable at the beginning of each year.
-Tyrrell agrees to pay all executory costs, which are expected to be $1,100 annually, including property taxes of $500, insurance of $350, and maitenance of $250.
-The cultivator has an estimated economic life of 6 years.
-Scupper guarantees a residual value of $60,000 at the end of 6 years.
-The interest rate implicit in the lease is 14%, which is known by Scupper.
-Scupper's incremental borrowing rate is 15%, and it uses the sum-of-the-years' digits method to record depreciation on similar equipment.
-The cost and rair value of the cultivator to Tyrrell is $271,154.68
-The lessor incures no material initial direct costs.
- The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be inccurred by the lessor.
Required:
1. Identify the type of lease involved for both Scupper and Tyrrell and give reasons for your classifications.
2. Prepare the journal entries for both Scupper and Tyrrell for 2016 (hint: scupper should expense executory costs when annual payments are made to tyrrell.)
Explanation / Answer
Answer to Part 1
The criteria for a capital lease can be any one of the following four alternatives:
PV(Lease Payments)=(Yearly Lease payments-Executory cost) PV factor of n payments at discount rates+Guaranteed residual value.
The firm is paying $56,100 annually for at the implicit rate of 14%. The executory cost is $1,100.
PV(Lease payments)=($56,100-$1,100)x4.433081 + ($60,000x0.455587)=$271,154.68
The minimum lease payment is $271,154.68 which is 100% of the equipment fair market value. Hence the condition is satisfied.
Hence the lease is capital lease.