17.8 Exercises
Chapter 17
Exercise 17.1
Below is information about a lease agreement signed by Oakland Ltd. (lessee) and Hartford Corp. (lessor). Both follow ASPE.
| Type of lease | non-cancellable |
| Lease date | July 1, 2021 |
| Annual lease payment amount in advance | $25,100 |
| Bargain purchase option at the end of the lease term | $3,000 |
| Lease term | 6 years |
| Estimated economic life of the leased asset | 10 years |
| Residual value after 10 years | $1,500 |
| Lessor’s cost | $90,000 |
| Leased asset fair value, July 1, 2021 | $130,000 |
| Executory costs | paid directly by lessee |
| Lessee’s incremental borrowing rate | 8% |
| Lessor’s implicit rate (known to lessee) | 7% |
| Collectability of lease payments | no uncertainties |
| Costs not yet incurred by the lessor | no uncertainties |
| Year-end for lessee and lessor | December 31 |
Required:
- Analyze and classify the lease for both the lessee and lessor using data to support the classification.
- Calculate the gross and net investment amount as at July 1, 2021, for the lessor.
- Prepare a lease amortization schedule for the lessee and lessor over the term of the lease.
- Record the journal entries for 2021 and 2022 for the lessee.
- Record the journal entries for 2021 and 2022 for the lessor.
- Explain the differences, if any, to both the lessee and lessor if they followed IFRS (IAS 17).
- How might the depreciation differ had the lease included a guaranteed residual instead of a bargain purchase option?
Exercise 17.2
On January 1, 2021, Mercy Ltd. (lessee) signed an 8-year, non-cancellable lease agreement to lease a highly specialized landscaping machine from Bergess Corp. (lessor). The agreement is non-renewable and requires a cash payment of $46,754 each January 1, commencing in 2021. The yearly cash payment includes $2,000 of executory costs related to insurance on the machine. At the end of the lease term, the machine reverts to the lessor. The machine has an estimated economic life of 10 years and an unguaranteed residual value of $10,000. The fair value of the machine on January 1, 2021, was $270,000. Mercy Ltd. follows IFRS (IAS 17) and its year-end is December 31. Mercy Ltd. also uses the straight-line method for depreciation, and its incremental borrowing rate is 9% per year. Bergess Corp.’s rate, implicit in the lease, is not known to Mercy Ltd.
Required:
- Analyze and classify the lease for the lessee and the lessor.
- Prepare an amortization schedule for the term of the lease to be used by Mercy Ltd.
- Prepare all related journal entries for 2021 and 2022 for Mercy Ltd.
- Prepare Mercy Ltd.’s balance sheet and required disclosures for the lease for the fiscal year ending December 31, 2022.
Exercise 17.3
On January 1, 2021, Cappic Ltd. signed an 8-year, non-cancellable lease agreement to lease a highly specialized landscaping machine from Jedii Corp. The agreement is non-renewable and requires the payment of $50,397 every January 1, starting in 2021. The yearly rental payment includes $2,500 of executory costs related to a maintenance contract on the machine, and at the end of the lease term, the machine reverts to the lessor. The machine has an estimated economic life of 12 years, with an unguaranteed residual value of $22,000. Cappic Ltd. uses the straight-line method for depreciation, and the fair value of the machine on January 1, 2021, was $300,000. Cappic Ltd. follows IFRS (IAS 17) and its year-end is June 30. Additionally, its incremental borrowing rate is 8% per year. Jedii Corp.’s implicit rate is 9%, which is known to Cappic Ltd.
Required:
Prepare all related journal entries for 2021 and 2022 for the lessee.
Exercise 17.4
On January 1, 2021, Oberton Ltd. entered into an agreement to lease a truck from Black Ltd. The details of the agreement are as follows:
| Carrying value of asset for Black Ltd. | $18,000 | |
| Fair value of truck | $18,000 | |
| Economic life of truck | 6 years | |
| Lease term | 4 year | |
| Rental payments, annually, starting January 1, 2021 | $4,333 | |
| Executory costs included in each rental payment for insurance | $20 | |
| Incremental borrowing rate for Oberton Ltd. | 6% | |
| Lessor’s effective interest rate | 8% | |
| Guaranteed residual value | $3,500 |
Additional information:
- There are no uncertainties regarding lease payments or additional un-reimbursable costs.
- At the end of the lease term, Black Ltd. sold the truck to a third party for $3,200, which was the truck’s fair value on January 1, 2025. Oberton Ltd. paid Black Ltd. the difference between the guaranteed residual value of $3,500 and the proceeds obtained on the resale.
- Oberton Ltd. knows the interest rate that is implicit in the lease.
- Oberton Ltd. knows the amount of executory costs included in the minimum lease payments.
- Oberton Ltd. uses straight-line depreciation for its assets.
- Both Oberton Ltd. and Black Ltd. use IFRS (IAS 17) and their year-ends are both December 31.
Required:
- Discuss the nature of this lease for both Oberton Ltd. (the lessee) and Black Ltd. (the lessor).
- Prove the effective interest rate of 8% using a financial calculator.
- Prepare a lease amortization schedule for the full term of the lease.
- Prepare all related journal entries for Oberton Ltd. over the period from January 1, 2021, to January 1, 2022, including any year-end adjusting journal entries. Assume that Oberton Ltd. does not use reversing entries.
- Prepare Oberton Ltd.’s partial classified statement of financial position at December 31, 2021, along with relevant note disclosures and the income statement for the fiscal year ending December 31, 2021.
- Prepare the journal entry for Oberton Ltd.’s payment on January 1, 2025, to Black Ltd. to settle the guaranteed residual value deficiency. Assume that the year-end depreciation has been already recorded but that no accruals for interest have been recorded as yet during 2024.
- Prepare all relevant journal entries that Black Ltd. would record from January 1 to December 31, 2021.
- Prepare a partial income statement for Black Ltd. for the year ended December 31, 2021.
Exercise 17.5
Helmac Ltd. manufactures equipment and leased it to Tolmin Ltd. for a period of ten years beginning on January 1, 2021. The equipment has an estimated economic life of twelve years. The equipment’s normal selling price is $299,122, and its unguaranteed residual value at the end of the lease term is estimated to be $25,000. Tolmin Ltd. will pay annual payments of $35,000 at the beginning of each year, as well as all maintenance and insurance costs over the lease term. The cost to manufacture the equipment was $100,000. Helmac Ltd. also incurred $10,000 in closing lease costs. Helmac Ltd. has determined that there is no uncertainty with regard to the collectability of the lease payments or additional costs. The lessee’s incremental borrowing rate is 6% and the lessor’s effective interest rate is 5%, which is known to the lessee. Both Helmac Ltd. and Tolmin Ltd. follow ASPE.
Required:
- Discuss the nature of this lease in relation to the lessor.
- Prepare all of the lessor’s journal entries for the first year of the lease, assuming the lessor’s fiscal year-end is five months into the lease. Reversing entries are not used.
- How would the initial entry to record the lease change if $25,000 residual value was guaranteed by the lessee?
- Assume now that the lease term is for 12 years. How much would Helmac Ltd. charge the lessee annually for a 12-year lease, if the sales price and interest rate remains unchanged, but the residual value was $40,000 and unguaranteed by the lessee?
Exercise 17.6
On January 1, 2021, Kimble Ltd. sells specialty equipment to Quick Finance Corp. for $432,000 and immediately leases the equipment back from them. Other relevant information is as follows:
- The equipment has a fair value of $432,000 on January 1, 2021, and an estimated economic life of 10 years, with no residual value.
- The equipment’s carrying value on Kimble Ltd.’s books on January 1, 2021, is $385,000.
- The term of the non-cancellable lease is 10 years and the title (legal title for ownership) will transfer to Kimble Ltd. at the end of the lease due to its specialty.
- The lease agreement requires equal payments of $61,507 at the end of each year.
- The incremental borrowing rate of Kimble Ltd. is 8%. The effective interest rate for Quick Finance Corp. is set to return 7% and is known by Kimble Ltd.
- Kimble Ltd. pays executory costs of $7,200 per year directly to appropriate third parties.
- Both Kimble Ltd. and Quick Finance Corp. use ASPE. No uncertainties exist regarding future unrecoverable costs and collectability is reasonably certain.
Required:
- Demonstrate how this lease meets the criteria for classification as a capitalized lease.
- Prepare the journal entries for both the lessee and the lessor for 2021 to reflect the sale and leaseback agreement.
Exercise 17.7
On January 1, Y2, Hamilton Corp, which follows IFRS, signed a 10-year, lease agreement to lease equipment from Welland Corp.
The following information about the lease is available:
- The agreement requires equal lease payments of $56,808 beginning January 1, Y2.
- The fair value of the equipment is $359,500 on January 1, Y2.
- The lease is non-renewable. At the termination of the lease, the equipment reverts to the lessor.
- The equipment has an estimated economic life of 12 years.
- There is an unguaranteed residual value of the equipment of $10,000.
- Depreciation is based on the straight-line method.
- Hamilton Corp has an incremental borrowing rate of 12%. The lessor’s rate, is not known by Hamilton.
Required:
- Determine the present value of the lease payment and create an amortization schedule for Hamilton.
- What type of lease is this? (operating or capital).
- Prepare the required and necessary journal entries for Hamilton for Y2 and Y3.
- How would the lease be reported in the notes to the financial statements at Y3?
Exercise 17.8
On January 1, Y4, Kitchener leased equipment to Waterloo. Both companies have a December 31 year end and both companies follow IFRS.
The following information is important for this lease:
- The term of the lease is six years, it is non-cancelable and non-renewable.
- Lease payments are to be paid in the amount of $24,516 beginning on January 1, Y4.
- The equipment has an economic life of seven years.
- The fair value of the equipment on January 1, Y4 is $117,450 and the cost is $86,325.
- Collectibility of lease payments is reasonably predictable and there are no important uncertainties about any unreimburseable costs.
- Both companies have an implicit rate of 10%.
Required:
- What type of lease is this? (operating/capital); (direct financing/sales)
- Determine the present value of the lease and prepare the amortization schedule.
- Prepare the journal entries for both the lessee AND lessor for Y4 and Y5.
Exercise 17.9
On January 1, Y5, Min Limited leased equipment to Paulus Corp. Both companies follow ASPE and both companies have a December 31 year end.
The following information relates to the lease agreement.
- The term of the lease is five years, it is non-cancelable and no renewal option.
- The equipment has an estimated economic life of six years.
- The assets value value at January 1, Y5 is $147,980.
- The lease agreement requires equal annual rental payments of $32,552 beginning January 1, Y5.
- The incremental borrowing rate is 5% for both companies.
- Straight-line depreciation is used by both companies.
Required:
- What type of lease is this? (operating/capital); (direct financing/sales)
- Determine the present value of the lease and prepare the amortization schedule.
- Prepare the journal entries for both the lessee AND lessor for Y5 and Y6.
