Part I: Taking the Same Lease through Multiple Variations
On January 1, 2010, BigRigs leased a truck with a fair market value of $369,506 to Urankar's delivery services. The lease is noncancellable and guarantees a residual value of $125,000 on the truck at the end of the lease term in 5 years (the economic life of the truck is 6 years). BigRigs wants to earn effective interest of 10% on the deal with payments due annually at the start of the year. Assume Urankar's discount rate is also 10%
A) What payments must BigRigs charge if it wants the lease cash flows to equal the fair market value of the truck and earn 10% on the transaction?
B) Would the required payments change if the GRV was a BPO? If so, how?
C) Would the required payments change if the GRV was a UGRV? If so, how?
D) Would the required payments change if there was no terminal value (i.e. no BPO, GRV or UGRV)?
E) Provide journal entries for the nception of the lease agreement forBigRigs AND Urankar if i) the cost to BigRigs was $369,506 ii) the cost was $320,000? (assume the GRV)
F) Assume the lease was classified as sales-type. How would the journal entries for Urankar and BigRigs you recorded in E change if the GRV was a UGRV of $125,000 and the cost of the truck was $320,000?
G) Assuming Urankar uses straight-line depreciation, how would Urankar record depreciation for 2010 under the following situations? Assume, where appropriate, the salvage value of the truck at the end of its economic life (i.e. the sixth year) is $75,000.
i) BPO at the end of the fifth year, exercisable for $150,000.
ii) GRV at the end of the fifth year, guaranteed at $150,000.
Part II: Journalizing a Lease with Different Rates and End of Lease Transactions
On January 1, 2013, Neeko (the lessee) entered a lease agreement with Merrick (the lessor) stipulating the following terms:
Annual payments: $225,000 due January 1, beginning immediately
End of term value: Guaranteed Residual Value of $150,000
Neeko's incremental borrowing rate: 10%
Merrick's internal rate of return: 11%
Lease term: 5 years
The leased asset has an economic life of 6 years. There is no transfer of title or bargain purchase option included in the transaction. Assume the cost of the leased asset is $700,000 to Merrick.
A. Provide the 1/1/13 journal entries for the inception of the lease agreement for Neeko and Merrick.
B. Calculate and provide the year-end expenses/revenues recognized by Neeko and Merrick during 2013.
C. Provide the journal entry for the second cash payment that is due on 1/1/14.
D. Suppose it is now January 1, 2018 (the end of the lease term). What journal entries should be recorded by Neeko and Merrick if the fair market value of the leased asset is $120,000? How would the journal entries change if the GRV were a UGRV and the leased asset were still worth $120,000 at the end of the lease term?