AC3202 Corporate Accounting I, Semester A, 2018/19 (Weeks 7-9)

Accounting for Leases - Assignment

Question 1
On January 1, 2016, A Ltd. signed a 10-year non-cancelable lease agreement to lease a
storage building from S Ltd. The following information pertains to this lease agreement.
 The agreement requires equal rental payments of $144,000 each January 1, starting 1
January 2016.
 The fair value of the building on 1 January 2016 is $880,000.
 The building has an estimated economic life of 12 years, with an unguaranteed residual
value of $20,000. A Ltd. depreciates similar buildings on the straight-line method.
 The lease is nonrenewable. At the termination of the lease, the building reverts to the
lessor.
 A Ltd.’s incremental borrowing rate is 12% per year. The lessor’s implicit rate is not
known by A Ltd.
 The yearly rental payment includes $4,941 of cost related to taxes on the property.

Required:
Prepare the journal entries on the A Ltd’s books to reflect the signing of the lease agreement
and to record the payments and expenses related to this lease for the years 2016 and 2017. A
Ltd.’s year end is December 31.

Question 2
On 1 January 2016, A Ltd leased equipment to B Ltd. for a four-year period ending 31
December 2019, at which time possession of the leased asset will revert back to A Ltd. The
cash price of the equipment is $365,760 and has an expected useful life of six years. The
expected residual value of $25,000 at 31 December 2019, is not guaranteed. Equal payments
under the lease are $100,000. The first payment was made on 1 January 2016, and subsequent
payments due on 31 December of each year. Both companies have the accounting period
ended at 31 December of each year. B Ltd’s incremental borrowing rate is 12%. B Ltd.
knows the interest rate implicit in the lease payments is 10%. Both companies use straight-
line depreciation method.

Required:
(a) How should this lease be classified by B Ltd. (the lessee)? Why?
(b) Prepare the appropriate entries for B Ltd. for the year of 2016.
(c) Prepare the appropriate entries for B Ltd. on 31 December 2019, assuming the equipment
is returned to A Ltd. and the actual residual value on the date is $1,500.

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Question 3
S Ltd. leased a new piece of equipment to Y Ltd. under a 5-year non-cancelable contract
starting 1 January 2016. Terms of the lease require payments of $22,000 each January 1,
starting 1 January 2016. S Ltd. will pay insurance, taxes, and maintenance charges on the
equipment, which has an estimated life of 12 years, a fair value of $160,000, and a cost to S
Ltd. of $160,000. The estimated fair value of the equipment 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 S Ltd. and Y Ltd. adjust and close books annually at December 31. Y Ltd’s incremental
borrowing rate is 10%, and S Ltd’s implicit interest rate of 9% is known to Y Ltd. Although
the lease term is 5 years, however, the leased equipment is of low value.

Required:
(a) Identify the type of lease involved and give reasons for your classification. Discuss the
accounting treatment that should be applied by lessor.

(b) Prepare all the entries related to the lease contract and leased asset for the year 2016 for
lessor, assuming:
(i) Insurance, $500
(ii) Taxes, $2,000
(iii) Maintenance, $650
(iv) Straight-line depreciation and salvage value, $10,000.