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EXERCISE 3-2 Accounting for Leases the Lessee GERCISE 3-3 Distinguishing and (Prating Leases On January 1, Year 8, Von Company entered into two noncancellable leases ofnew machines use in its manufacturing operations. Ihe first lease does not contain a bargain purchase option and the lease term is equal to Of the estimated economic life Of the machine. second lease contains a bargain purchase option and the lease tenn is equal to Of the estimated economic life Of the machine. Requ&ed: a. Explain the justification for requiring lessees tocapitalizecertain long-term leases. limit FM discussion to the specific criteria tor classifying a lease as a capital lease. b. Describehowa lessee accounts fora capital lease at inception. c. Explain how a records each minimum lease payment for a capital lease. d. Explain how Von should classify each of the two leases. Prwide justification. (AICPA Capital leases and operating leases are two major classifications ofleases. Requied: a. Describe how a lesse accounts for a capital lease both at inception of the lease and during the first par of the lease. Assume the lease transfers ownership of the property to the lessee by the end ot the lease. b. Describe a lessee accounts for an operating lease both at irreption of the lease and during ttp first par of the lease. Assume the lessee makes equal monthly payments at the beginning of each month during the lease term. Describe any changes in the accounting when rental payments are not made on a straight-line basis. Note: DO not discuss the criteria for distinguishing between capital and operating On January 1, Year 1. Burton Company leases equipment from Nelson Company for an annual lease rental of SIO.OOO. lease term is five years. and the lessor's interest rate implicit in the lease is "Ilie lessee's incremental borrowing rate is 8.25%. "Ille useful life of the equipment is five years, and its estimated residual value equals its removal cost. Annuity tables indicate that the present value of an annual lease rental of Sl eat 800 rate) is S3.993. fair value of leased equip- ment equals the present value of rentals. (Assume the lease is capitali7Rd.) a. b. C. d. e. Prepare accounting entries required by Burton Company for Year l. Compute and illustrate the effect on the income statement for the year ended December 31, Year l, and for the balance sheet as of December 31, Year l. Construct a table showing payments of interest and principal made every year for the five-year lease term. Construct a table showing expenses charged to the income statement for the five-year lease term if the equip- ment is purchased. Show a column for (l) amortization, (2) interest, and (3) total expenses. Discuss the income and cash flow implications from this capital lease. (AICPA PROBLEM 3-2 Capital Implications F CHECK Interest $2,649.95 fM Year 2 PROBLEM 3-4 Bond AcrouM1hg CHECK (1$55.36 millim PROBLEM J-s and Cybernetics Inc. issued S60 million of three-year bonds. with coumn paid at the end of every year. &ctive interest rate at the Of Years l, 2, and 3 was Requfed: a. b. c. d. what Cybrptics muld have raised trom the bmd issue Assume Cybernetics dEides to account for the bonds using the amortized cost . Determine the interest and bond amortization tor each of the three years. Assume Cybenetks deci&s to account for the bonds using the fair value method. Determine the interest. un- realized gainnoss, and total expense fM each of the thre years. Explain why the amounts charged to income every year differ under the two methods. Westfield Capital Management Co.'s equity investment stratew is to invest in companies with low price-to-book ratios. whde considering differences in solvency and asset utilization. Westfield is considering investing in the shares of either Jerry's Departmental Stores (JDS) or Miller Stores (MIS). Selected financial data for both companies SELECTED FINANCIAL DATA AS OF MARCH 31.2006 Sales Fixed assets.. Short-term debt... . Lmg-term debt Equity Outstanding shares (in millions). .. . Strk price ($ share) . Requied: a. Compute each of the following ratios fr (l) Price-to-book ratio (2) ratio (3) Fixed-asset-utilization (turnover) b. Select the company that better meets criteria. JDS $21,250 5,100 2.700 6.000 51.50 $18,500 5500 1,000 2,500 7.500 49.50