The head office of North Central Ltd. has operated in the western provinces for almost 50 years. North Central uses ASPE. In 2001, new offices were constructed on the same site at a cost of $9.5 million. The new building was opened on January 4, 2002, and was expected to be used for 35 years, at which time it would have a value of approximately $2 million.
In 2017, as competitors began to consider merger strategies among themselves, North Central felt that the time was right to expand the number of its offices throughout the region. This plan required significant financing and, as a source of cash, North Central looked into selling the building that housed its head office. On June 29, 2017, Rural Life Insurance Ltd. purchased the building (but not the land) for $8 million and immediately entered into a 20-year lease with North Central to lease back the occupied space. The terms of the lease were as follows.
1. It is non-cancellable, with an option to purchase the building at the end of the lease for $1 million.
2. The annual rental is $838,380, payable on June 29 each year, beginning on June 29, 2017.
3. Rural Life expects to earn a return of 10% on its net investment in the lease, the same as North Central's incremental borrowing rate.
4. North Central is responsible for maintenance, insurance, and property taxes.
5. Estimates of useful life and residual value have not changed significantly since 2001. Straight-line depreciation is used by North Central.
Instructions
(a) Using time value of money tables, a financial calculator, or Excel functions, calculate the lease payment that Rural Life would require from North Central. Use Excel and prepare a lease amortization schedule for the first two payments. Round all amounts to the nearest dollar.
(b) Prepare all entries for North Central Ltd. from June 29, 2017 to December 31, 2018. North Central has a calendar year fiscal period.
(c) Assume instead that there was no option to purchase, that $8 million represents the building's fair value on June 29, 2017, and that the lease term was 12 years. Prepare all entries for North Central from June 29, 2017 to December 31, 2018.
(d) Besides the increase in cash that it needs from the sale of the building, what effect should North Central expect to see on the net assets appearing on its statement of financial position immediately after the sale and leaseback?