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Acct.

414 Spring 2006

Extra example problem on leases (old exam question)

On August 1, 1993, Idaho Think Tank (lessee) and Colfax Computer Industries
(lessor) sign a lease with the following terms:

1. Term: 5 years 2. Annual payments of $39,000


3. Implicit interest rate (not known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $168,834 6. Cost of asset $130,000 (not known to lessee)
7. Incremental borrowing rate: 12% 8. First payment due 8/1/93
9. Estimated useful life of asset: 7 years 10. No collection or cost uncertainties for lessor
11. Est. fair value of asset at end of lease: $10,000 12. The residual value is NOT guaranteed by lessee
13. A commission of 1% of the sales price (PVMLP) 14. Lessor and lessee both use straight-line
is paid to the salesperson who negotiated the depreciation method for fixed assets.
lease.

a. Classify this lease from the perspective of the lessee. Explain.

b. Prepare all necessary journal entries for Idaho Think Tank at 8/1/93 and 12/31/93 (end of fiscal year).

c. Classify this lease from the perspective of the lessor. Explain.

d. Prepare all necessary journal entries for Colfax Computer Industries (CCI) at 8/1/93 and 12/31/93 (end of
fiscal year).
Acct. 414 Spring 2006

Solution to extra lease example problem (old exam question):


Lease Lessee Lessor
Old Capital PVMLP 12% Partial year Sales PVMLP 10% Unguaranteed
Exam accruals Type residual value, initial
direct cost

a) There is no Title Transfer and no BPO. The lease term is 71% of economic life. The only way this can be a
capital lease is if the PV of MLP is greater than 90% * 168,834 = 151,951. The lessee uses a 12% interest
rate and ignores the unguaranteed residual value. Therefore, the PVMLP = 157,457 and the lease is a
capital lease for the lessee.

b) 8/1/93 Leased Asset 157,457


Lease obligation 157,457

Lease obligation 39,000


Cash 39,000
12/31/93 Depreciation expense 13,121
Accumulated depreciation 13,121
Interest expense 5,923
Lease obligation 5,923
Based on amortization table:
Date Payment Interest 12% Principal Balance
8/1/93 157,457.00
8/1/93 39,000.00 0.00 39,000.00 118,457.00
8/1/94 39,000.00 14,214.84 24,785.16 93,671.84
8/1/95 39,000.00 11,240.62 27,759.38 65,912.46
8/1/96 39,000.00 7,909.50 31,090.50 34,821.96
8/1/97 39,000.00 4,178.63 34,821.37 0.00

c) This is a sales type lease because there is a profit (FMV is not equal to cost), because the PV of the MLP >
90% of FMV and because there are no cost or collection uncertainties.
d) 8/1/93 Salary expense (commission) 1,626
Cash 1,626
Net investment in lease 168,834
COGS (reduced by PV of RV) 123,791
Inventory 130,000
Sales 162,625
Cash 39,000
Net investment in lease 39,000
Optional entry to put commission in cost of sales
COGS (initial direct cost-commission) 1,626
Salary expense (commission) 1,626
12/31/93 Net investment in lease 5,410
Interest revenue 5,410
Based on amortization table:
Date Payment Interest 10% Principal Balance
168,834
8/1/93 39,000 0 39,000 129,834
8/1/94 39,000 12,983 26,017 103,817
8/1/95 39,000 10,382 28,618 75,199
8/1/96 39,000 7,520 31,480 43,719
8/1/97 39,000 4,372 34,628 9,091
8/1/98 10,000 909 9,091 0
Acct. 414 Spring 2006

205,000 36,166 168,834

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