Financing Lease (or sales type lease) LESSEE'S PERSPECTIVE Assume that on December 31, 2019, Waste Management, Inc. signs an 8-year noncancelable lease agreement to lease a building from Reyes Warehouse Company. The following information pertains to this lease agreement. 1. The agreement requires equal rental payments of $62,755 beginning on December 31, 2019. 2. The fair value of the building on December 31, 2019, is $425,000. 3.The building has an estimated economic life of 10 years, a guaranteed residual value at the end of 8 years of $19,000, and an expected residual value of $13,500. Waste Management depreciates similar buildings using the straight-line method. 4.The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor. 5.Waste Management's incremental borrowing rate is 6% per year. The lessor's implicit rate is not known by Waste Management. Why is this a financing lease? Hint: there are two reasons. What type of financing lease is this from Waste Management's perspective? How does a guaranteed residual value effect the recorded lease liability? Prepare Waste Mangement's, journal entries at the inception of the lease. Debit Credit Implicit Interest Rate 6% 12/31/19 Time Payment Interest Principle Balance Debit Credit 12/31/19 Prepare Waste Mangement's entries on 12/31/2020 62,755 1 62,755 62,755 62,755 62.755 5 62,755 61 62,755 7 62,755 75,500 Debit Credit 12/31/20 JIU2,1 JJ Debit Credit 12/31/20 662,755 7 62,755 75,500 Record the payment Debit Credit 12/31/20 Prepare Waste Mangement's entries on 12/31/2021 Debit Credit 12/31/21 Record the payment Debit Credit 12/31/21) Implicit Interest Rate 6% Suppose that in addition to the $62,755 annual rental payments, Waste Management is also required to pay $8,000 for insurance costs each year on the building directly to the lessor, Reyes Warehouse Company. How would this executory cost affect the initial measurement of the lease liability and right-of-use asset? Time Payment Interest Principle Balance Right-of-use asset T L L ol s 70.755 1 70.755 21 70.755 31 70.755 40 70.755 5 70,755 6 70,755 70.755 5 ,500 Now suppose that, at the end of the lease term, Waste Management and Reyes agree that the fair value of the asset is actually $19,000. 7 7 | Record the entry for Waste Management at the end of the lease to return control of the warehouse building to Reyes (assuming the accrual of interest on the lease liability has already been made). Debit Credit 12/31/27 Lease liability - 5,500 Gain - 5,500