Refer to the data and other information provided in E20–2.
In E On September 1, 2011, Wong Corporation, which uses private enterprise GAAP, signed a five-year, non-cancellable lease for a machine. The terms of the lease called for Wong to make annual payments of $13,668 at the beginning of each lease year, starting September 1, 2011. The machine has an estimated useful life of six years and a $9,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Wong uses the straight-line method of depreciation for all of its plant assets, has a calendar year end, prepares adjusting journal entries at the end of the fiscal year, and does not use reversing entries. Wong’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.
Assume that the machine has an estimated economic life of seven years and that its fair value on September 1, 2011, is $79,000.
Instructions
(a) Explain why this lease is now considered an operating lease.
(b) Prepare all necessary journal entries for Wong Corporation for this lease, including any year-end adjusting entries through December 31, 2012.
(c) Identify what accounts will appear on Wong’s December 31, 2011 statement of financial position and income statement relative to this lease.
(d) How would Wong’s December 31, 2011 statement of financial position and income statement differ from your answer to (c) if the lease were a capital lease as described in E20–2?
(e) What major financial statement ratios would be different if Wong accounted for this lease as an operating lease rather than as a capital lease? Explain.