ohnson Ltd , a Canadian company that applies IFRSs, leased equipment from Lessor Inc on January 1, 2010, for a period of three years Lease payments of $200,000 are due to Lessor Inc each year Other expenses (e g , insurance, taxes, maintenance) are also to be paid by Lessee Ltd and amount to $4,000 per year The lease contains no purchase or renewal options and the equipment reverts back to Lessor Inc on the expiration of the lease The useful life of the equipment is four years The fair value of the equipment at lease inception is $550,000 Lessee Ltd has guaranteed $40,000 as the residual value at the end of the lease term The salvage value of the equipment is expected to be $10,000 after the end of its economic life The lessee s incremental borrowing rate is 12 percent (Lessor s implicit rate is 11 percent and is calculable by the lessee from the lease agreement) The junior accountant of Lessee Ltd analyzed the assets under lease and prepared a computation The senior accountant of Lessee Ltd reviewed the analysis and the computation and prepared a separate analysis As the finance controller, you were given both of the computations to determine the correct accounting treatment Calculations and journal entries performed by your junior and senior accountant are shown below Computations by the junior accountant Since the equipment reverts back to Lessor Inc , it is an operating lease Entries to be posted in Years 1, 2, and 3 Dr Rent expense $200,000 Dr Other expense $4,000 Cr Cash $204,000 (Operating lease rental paid to Lessor Inc ) Computations by the senior accountant Step 1 Lease classification The lease term is for three years The useful life of the equipment is four years Since the lease term is for a major part of the useful life of the equipment, it is a finance lease Step 2 Computation of the lease asset and obligation Since the lessee s incremental borrowing rate is greater than the lessor s implicit rate in the lease, compute the present value of the minimum lease payments using the 12 percent rate Present value of the minimum lease payments $200,000 2 40183 $480,366 Step 3 Allocation of payments between interest and lease obligation Since interest has to be charged on the straight line method, the following is the allocation of the interest and the reduction in the lease liability Year Cash Payment Interest Expense (12 ) Reduction in Lease Obligation Balance of Lease Obligation Interest Reduction in Balance of Year Cash payment Expense (12 ) Lease Obligation Lease Obligation $ $ $ $ 0 480,366 1 200,000 57,643 142,357 338,009 2 200,000 57,643 142,357 195,652 3 200,000 57,643 142,357 53,295 Year 1 Journal Entries To record the leased asset obligation Dr Finance lease asset $480,366 Cr Finance lease obligation $480,366 To record the cash payment Dr Other expense $4,000 Dr Finance expense $57,643 Dr Lease obligation $142,357 Cr Cash $204,000 To record depreciation Dr Depreciation $117,592 Cr Accumulated depreciation $117,592 Depreciable amount $470,366 ($480,366 $10,000 (salvage value)) Annual depreciation charge $117,592 ($470,366 4 years) Required 1 Was the junior accountant s analysis correct Why or why not 2 Was the senior accountant s analysis correct Why or why not 3 How would the answer differ under U S GAAP References ASC 840 and IAS 17 Johnson Ltd Johnson Ltd , a Canadian company that applies IFRSs, leased equipment from Lessor Inc on January 1, 2010, for a period of three years Lease payments of $200,000 are due to Lessor Inc each year Other expenses (e g , insurance, taxes, maintenance) are also to be paid by Lessee Ltd and amount to $4,000 per year The lease contains no purchase or renewal options and the equipment reverts back to Lessor Inc on the expiration of the lease The useful life of the equipment is four years The fair value of the equipment at lease inception is $550,000 Lessee Ltd has guaranteed $40,000 as the residual value at the end of the lease term The salvage value of the equipment is expected to be $10,000 after the end of its economic life The lessee's incremental borrowing rate is 12 percent (Lessor's implicit rate is 11 percent and is calculable by the lessee from the lease agreement) The junior accountant of Lessee Ltd analyzed the assets under lease and prepared a computation The senior accountant of Lessee Ltd reviewed the analysis and the computation and prepared a separate analysis As the finance controller, you were given both of the computations to determine the correct accounting treatment Calculations and journal entries performed by your junior and senior accountant are shown below Computations by the junior accountant Since the equipment reverts back to Lessor Inc , it is an operating lease Entries to be posted in Years 1, 2, and 3 Dr Rent expense $200,000 Dr Other expense $4,000 Cr Cash $204,000 (Operating lease rental paid to Lessor Inc ) Computations by the senior accountant Step 1 Lease classification The lease term is for three years The useful life of the equipment is four years Since the lease term is for a major part of the useful life of the equipment, it is a finance lease Step 2 Computation of the lease asset and obligation Since the lessee's incremental borrowing rate is greater than the lessor's implicit rate in the lease, compute the present value of the minimum lease payments using the 12 percent rate Present value of the minimum lease payments $200,000 2 40183 $480,366 Step 3 Allocation of payments between interest and lease obligation Since interest has to be charged on the straight line method, the following is the allocation of the interest and the reduction in the lease liability Year Cash Payment Interest Expense (12 ) Reduction in Lease Obligation Balance of Lease Obligation Year 0 1 2 3 Cash payment $ Interest Expense (12 ) $ Reduction in Lease Obligation $ 200,000 200,000 200,000 57,643 57,643 57,643 142,357 142,357 142,357 Year 1 Journal Entries To record the leased asset obligation Dr Finance lease asset Cr Finance lease obligation $480,366 $480,366 To record the cash payment Dr Other expense Dr Finance expense Dr Lease obligation Cr Cash $4,000 $57,643 $142,357 $204,000 To record depreciation Dr Depreciation Cr Accumulated depreciation $117,592 $117,592 Depreciable amount $470,366 ($480,366 $10,000 (salvage value)) Annual depreciation charge $117,592 ($470,366 4 years) Required 1 Was the junior accountant's analysis correct Why or why not 2 Was the senior accountant's analysis correct Why or why not 3 How would the answer differ under U S GAAP References ASC 840 and IAS 17 Balance of Lease Obligation $ 480,366 338,009 195,652 53,295

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ohnson Ltd., a Canadian company that applies IFRSs, leased equipment from Lessor Inc. on January 1, 2010, for a period of three years. Lease payments

ohnson Ltd., a Canadian company that applies IFRSs, leased equipment from Lessor Inc. on January 1, 2010, for a period of three years. Lease payments of $200,000 are due to Lessor Inc. each year. Other expenses (e.g., insurance, taxes, & maintenance) are also to be paid by Lessee Ltd. and amount to $4,000 per year. The lease contains no purchase or renewal options and the equipment reverts back to Lessor Inc. on the expiration of the lease. The useful life of the equipment is four years. The fair value of the equipment at lease inception is $550,000. Lessee Ltd. has guaranteed $40,000 as the residual value at the end of the lease term. The salvage value of the equipment is expected to be $10,000 after the end of its economic life. The lessee?s incremental borrowing rate is 12 percent (Lessor?s implicit rate is 11 percent and is calculable by the lessee from the lease agreement). The junior accountant of Lessee Ltd. analyzed the assets under lease and prepared a computation. The senior accountant of Lessee Ltd. reviewed the analysis and the computation and prepared a separate analysis. As the finance controller, you were given both of the computations to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant are shown below. Computations by the junior accountant: Since the equipment reverts back to Lessor Inc., it is an operating lease. Entries to be posted in Years 1, 2, and 3: Dr. Rent expense $200,000 Dr. Other expense $4,000 Cr. Cash $204,000 (Operating lease rental paid to Lessor Inc.) Computations by the senior accountant: Step 1 ? Lease classification The lease term is for three years. The useful life of the equipment is four years. Since the lease term is for a major part of the useful life of the equipment, it is a finance lease. Step 2 ? Computation of the lease asset and obligation: Since the lessee?s incremental borrowing rate is greater than the lessor?s implicit rate in the lease, compute the present value of the minimum lease payments using the 12 percent rate. Present value of the minimum lease payments = $200,000 2.40183= $480,366 Step 3 ? Allocation of payments between interest and lease obligation Since interest has to be charged on the straight-line method, the following is the allocation of the interest and the reduction in the lease liability. Year Cash Payment Interest Expense (12%) Reduction in Lease Obligation Balance of Lease Obligation Interest Reduction in Balance of Year Cash payment Expense (12%) Lease Obligation Lease Obligation $ $ $ $ 0 480,366 1 200,000 57,643 142,357 338,009 2 200,000 57,643 142,357 195,652 3 200,000 57,643 142,357 53,295 Year 1 Journal Entries: To record the leased asset/obligation: Dr. Finance lease asset $480,366 Cr. Finance lease obligation $480,366 To record the cash payment: Dr. Other expense $4,000 Dr. Finance expense $57,643 Dr. Lease obligation $142,357 Cr. Cash $204,000 To record depreciation: Dr. Depreciation $117,592 Cr. Accumulated depreciation $117,592 Depreciable amount = $470,366 = ($480,366 - $10,000 (salvage value)) Annual depreciation charge = $117,592 = ($470,366 / 4 years) Required 1. Was the junior accountant?s analysis correct? Why or why not? 2. Was the senior accountant?s analysis correct? Why or why not? 3. How would the answer differ under U.S. GAAP? References: ASC 840 and IAS 17 image text in transcribed

Johnson Ltd Johnson Ltd., a Canadian company that applies IFRSs, leased equipment from Lessor Inc. on January 1, 2010, for a period of three years. Lease payments of $200,000 are due to Lessor Inc. each year. Other expenses (e.g., insurance, taxes, & maintenance) are also to be paid by Lessee Ltd. and amount to $4,000 per year. The lease contains no purchase or renewal options and the equipment reverts back to Lessor Inc. on the expiration of the lease. The useful life of the equipment is four years. The fair value of the equipment at lease inception is $550,000. Lessee Ltd. has guaranteed $40,000 as the residual value at the end of the lease term. The salvage value of the equipment is expected to be $10,000 after the end of its economic life. The lessee's incremental borrowing rate is 12 percent (Lessor's implicit rate is 11 percent and is calculable by the lessee from the lease agreement). The junior accountant of Lessee Ltd. analyzed the assets under lease and prepared a computation. The senior accountant of Lessee Ltd. reviewed the analysis and the computation and prepared a separate analysis. As the finance controller, you were given both of the computations to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant are shown below. Computations by the junior accountant: Since the equipment reverts back to Lessor Inc., it is an operating lease. Entries to be posted in Years 1, 2, and 3: Dr. Rent expense $200,000 Dr. Other expense $4,000 Cr. Cash $204,000 (Operating lease rental paid to Lessor Inc.) Computations by the senior accountant: Step 1 Lease classification The lease term is for three years. The useful life of the equipment is four years. Since the lease term is for a major part of the useful life of the equipment, it is a finance lease. Step 2 Computation of the lease asset and obligation: Since the lessee's incremental borrowing rate is greater than the lessor's implicit rate in the lease, compute the present value of the minimum lease payments using the 12 percent rate. Present value of the minimum lease payments = $200,000 2.40183= $480,366 Step 3 Allocation of payments between interest and lease obligation Since interest has to be charged on the straight-line method, the following is the allocation of the interest and the reduction in the lease liability. Year Cash Payment Interest Expense (12%) Reduction in Lease Obligation Balance of Lease Obligation Year 0 1 2 3 Cash payment $ Interest Expense (12%) $ Reduction in Lease Obligation $ 200,000 200,000 200,000 57,643 57,643 57,643 142,357 142,357 142,357 Year 1 Journal Entries: To record the leased asset/obligation: Dr. Finance lease asset Cr. Finance lease obligation $480,366 $480,366 To record the cash payment: Dr. Other expense Dr. Finance expense Dr. Lease obligation Cr. Cash $4,000 $57,643 $142,357 $204,000 To record depreciation: Dr. Depreciation Cr. Accumulated depreciation $117,592 $117,592 Depreciable amount = $470,366 = ($480,366 - $10,000 (salvage value)) Annual depreciation charge = $117,592 = ($470,366 / 4 years) Required 1. Was the junior accountant's analysis correct? Why or why not? 2. Was the senior accountant's analysis correct? Why or why not? 3. How would the answer differ under U.S. GAAP? References: ASC 840 and IAS 17 Balance of Lease Obligation $ 480,366 338,009 195,652 53,295