On January 1, 2017, Lavery Corp., which follows ASPE, leased equipment to Flynn Ltd., which follows IFRS 16. Both Lavery and Flynn have calendar year ends. The following information concerns this lease.
1. The term of the non-cancellable lease is six years, with no renewal option. The equipment reverts to the lessor at the termination of the lease, at which time it is expected to have a residual value (not guaranteed) of $6,000. Flynn Ltd. depreciates all its equipment on a straight-line basis.
2. Equal rental payments are due on January 1 of each year, beginning in 2017.
3. The equipment's fair value on January 1, 2017 is $144,000 and its cost to Lavery is $111,000.
4. The equipment has an economic life of seven years.
5. Lavery set the annual rental to ensure a 9% rate of return. Flynn's incremental borrowing rate is 10% and the lessor's implicit rate is unknown to the lessee.
6. Collectibility of lease payments is reasonably predictable and there are no important uncertainties about any unreimbursable costs that have not yet been incurred by the lessor.
Instructions
(a) Explain clearly why this lease would be set up as a right-of-use asset by Flynn and a manufacturer/dealer or sales- type lease by Lavery.
(b) Using time value of money tables, a financial calculator, or Excel spreadsheet functions, calculate the amount of the annual rental payment.
(c) Prepare all necessary journal entries and adjusting entries for Flynn for 2017.
(d) Prepare all necessary journal entries and adjusting entries for Lavery for 2017.
(e) Discuss the differences, if any, in the classification of the lease by Lavery Corp. (the lessor) if Lavery were using IFRS 16.