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Lessor Lease Handouts Solutions

# Lessor Lease Handouts Solutions - Operating and Capital...

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Operating and Capital Lease Exercise – Lessor Part 1 On January 1, 2004, Barry Co., a lessor, entered into a lease agreement for equipment with Millikin Co., a lessee. The equipment leased to Millikin was purchased by Barry for \$100,000 immediately prior to the lease transaction. The noncancellable term of the lease is 4 years, and the estimated useful life of the equipment is 6 years. At the end of 6 years, the equipment will have no value. The lease requires annual payments of \$18,764, with the first payment due on January 1, 2004. Instead of leasing the equipment, Millikin could have borrowed the money to purchase the equipment from a local bank at 6% interest. Barry used a 5% rate of return when calculating the lease payments, and Millikin is aware of that rate. At the end of the lease, Millikin will return the equipment to Barry. Both Millikin and Barry depreciate assets using the straight-line method. a. Classify the lease for Barry. Operating Lease Four criteria: 1. Transfer of ownership? No 2. Bargain Purchase Option? No 3. Is the lease term equal to 75% or more of the estimated economic life of the leased property? No, because 4/6 = 67% 4. Is the present value of the minimum lease payments (excluding executory costs) equal to or greater than 90 percent of the fair value of the leased property? No, because PV of minimum lease payments are less than 90% of FMV of the leased property. n = 4 i = 5% \$18,764 x 3.72325 = \$69,863 PV of minimum lease payments 90% of FMV: \$100,000 x 90% = \$90,000

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Part 1 - Continued b. For Barry record journal entries on 1/1/04 and 12/31/04. Journal Entries: Debit Credit 1/1/2004 Cash 18,764 Unearned Rent Revenue 18,764 12/31/2004 Unearned Rent Revenue 18,764 Rent Revenue 18,764 Depreciation Expense 16,667 Accumulated Depreciation 16,667 (100,000 ÷ 6 = 16,667) OR 1/1/2004 Cash 18,764 Rent Revenue 18,764 12/31/2004 Depreciation Expense 16,667 Accumulated Depreciation 16,667 (100,000 ÷ 6 = 16,667) 2
Part 2 On January 1, 2004, Barry Co., a lessor, entered into a lease agreement for equipment with Millikin Co., a lessee. The equipment leased to Millikin was purchased by Barry for \$100,000 immediately prior to the lease transaction. The noncancellable term of the lease is 6 years, and the estimated useful life of the equipment is 6 years. At the end of 6 years, the equipment will have no value. The lease requires annual payments of \$18,764, with the first payment due on January 1, 2004. Instead of leasing the equipment, Millikin could have borrowed the money to purchase the equipment from a local bank at 6% interest. Barry used a 5% rate of return when calculating the lease payments, and Millikin is aware of that rate. At the end of the lease, Millikin will return the equipment to Barry. Both Millikin and Barry depreciate assets using the straight-line method. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs to be incurred by the lessor.

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