1 answer

Ayayai Corporation entered into a lease agreement on January 1, 2020, to provide Blossom Company with...

Question:

Ayayai Corporation entered into a lease agreement on January 1, 2020, to provide Blossom Company with a piece of machinery. The terms of the lease agreement were as follows.

1. The lease is to be for 3 years with rental payments of $13,936 to be made at the beginning of each year.
2. The machinery has a fair value of $58,000, a book value of $40,000, and an economic life of 8 years.
3. At the end of the lease term, both parties expect the machinery to have a residual value of $20,000, none of which is guaranteed.
4. The lease does not transfer ownership at the end of the lease term, does not have a bargain purchase option, and the asset is not of a specialized nature.
5. The implicit rate is 4%, which is known by Dawkins.
6. Collectibility of the payments is probable.

Evaluate the criteria for classification of the lease, and describe the nature of the lease.

For the lessee, it is a                                                                       operating leasesales-type leasefinance lease, and for the lessor, it is a                                                                       finance leasesales-type leaseoperating lease.

Prepare the amortization schedules Blossom will use over the lease term.

BLOSSOM COMPANY
Lease Amortization Schedule
Annuity-Due Basis
Date Annual Payment Interest
on Liability
Reduction of
Lease Liability
Lease Liability
1/1/20 $
1/1/20 $ $ $
1/1/21
1/1/22
Lease Expense Schedule
Date (A)
Straight-Line
Expense
(B)
Interest on
Lease Liability
(C)
Amortization of
Right-of-Use Asset (and Liability)
(A-B)
Carrying Value of Right-of-Use Asset
1/1/20 $
12/31/20 $ $ $
12/31/21
12/31/22

Prepare the 2020 journal entries for Blossom.

Date

Account Titles and Explanation

Debit

Credit

Jan. 1

(To record lease)

Jan. 1

(To record first lease payment)

Dec. 31

(To record lease expense and amortization)

Prepare the 2020 journal entries for Ayayai.

Date

Account Titles and Explanation

Debit

Credit

Jan. 1

(To record lease payments)

Dec. 31

(To record lease revenue)

Dec. 31

(To record depreciation)

Suppose the lease were only for one year instead of 3 years, with just one lease payment at the beginning of the lease term. Prepare any journal entries Blossom would need, assuming it elects to use the short-term lease option.

Date

Account Titles and Explanation

Debit

Credit

Jan. 1


Answers

A lease meeting any of the following 5 criteria is classified as financial lease
(a) Ownership is transferred at the end of the lease term
(b) A bargain purchase option for the leased asset exists
(c.) The lease term is primarily for the remaining economic life of the leased asset
(d) The present value of the lease payments and the residual value guarantees is
equal to or more than the fair value of the leased asset.
(e.) The leased asset has no altermnative use to the lessor at the end of its term
due to its specialized nature
Looking at the terms of the lease agreement between Ayayai Corporation and Blossom
Company, the lease would be classified as operating lease as it does not satisfy any of the
5 criteria stated above
Computation of Present Value of Lease Rentals
= P * (1-(1-r) ^-n)/r
where, P = Annual Lease Rent
r = rate of interest
n = period
Annual Lease Rental(P) $13,936
Rate of interest (r.) 4%
Period (n) 3
PV = P*(1-(1+r) ^-n)/r) $38,674
Fair value of the lease asset = $ 38,674
BLOSSOM COMPANY
Lease Amortization Schedule
Annuity- Due Basis
Date Annual
Payment
Interest on
Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/2020 $38,674
1/1/2020 $13,936 $1,547 $12,389 $26,285
1/1/2021 $13,936 $1,051 $12,885 $13,400
1/1/2022 $13,936 $536 $13,400 $0
Lease expense schedule
Date Straight
Line Expense
Interest on
Lease
Liability
Amortization of Right to use asset( and liability) (A-B) Carrying
Value of
Right to use asset
1/1/2020 $38,674
1/1/2020 $13,936 $1,547 $12,389 $26,285
1/1/2021 $13,936 $1,051 $12,885 $13,400
1/1/2022 $13,936 $536 $13,400 $0
Journal entries in the books of Blossom Corporation
Date Account Title and Explanation Debit Credit
Jan-1 Right of use Asset $38,674
Lease Liability $38,674
(To record lease)
Jan-1 Lease Liability $13,936
Cash $13,936
(To record first lease payment)
Dec 31 Lease Expense $13,936
Lease Liability $1,547
Right of use Asset $12,389
(To record lease expense and amortization)
Journal entries in the books of Ayayai
Date Account Title and Explanation Debit Credit
Jan-1 Cash $13,936
Lease Receivable Account $13,936
(To record lease payment)
Jan-1 Lease Receivable Account $13,936
Lease Rental Income $13,936
(To record lease revenue)
Dec 31 Depreciation Expense $5,000
Accumulated Depreciation - Leased Machinery $5,000
(To record depreciation)
Note - Book value of asset in the books of Ayayai is $ 40,000 and useful life is 8 years
Depreciation = Book Value/Useful Life = $ 40,000/8 = $ 5,000
In case of short term lease,the accounting for the lease is done in the same way as it is done in
Operating lease
The details of this short term lease would be as under
Annual Lease Rental(P) $13,936 where, P = Annual Lease Rent
r = rate of interest
n = period
Rate of interest (r.) 4%
Period (n) 1
PV = P*(1-(1+r) ^-n)/r) $13,400
Fair Value of the asset = $ 13,400
Journal entries in the books of Blossom Corporation
Date Account Title and Explanation Debit Credit
Jan-1 Right of use Asset $13,400
Lease Liability $13,400
(To record lease)
Jan-1 Lease Liability $13,936
Cash $13,936
(To record first lease payment)
Dec 31 Lease Expense $13,936
Lease Liability $536
Right of use Asset $13,400
(To record lease expense and amortization)
.

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