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This assignment consists of two independent situations that require students to research Lease Accounting (Topic 842) in the Financial Accounting Standards Board’s (FASB) Codification.
When answering the questions in the two situations use the rules of Accounting Standards Update (ASU) No. 2016-02 dated February 2016, which becomes effective during 2019. Do not use existing lease rules to answer the questions.
In each of the two situations, fully explain your calculations to Winslow’s management. This is a writing assignment as well as a research assignment. No credit will be given for calculations that are not fully explained.
According to the proposed accounting standard updates on Leases (842-10-25-2) presented by FASB, a lessee is required to classify the lease transactions from the commencement date. As per the ASC 842 Glossary, leasing date is considered as the date on which underlying assets are available for use of lessee. In addition, a lease transaction is required to be classified as finance lease if the lease transaction meets any of the five criteria as specified under ASC 842 (Fasb.org, 2017). In case the transactions does not comply any of the criteria, then the lease will be classified as an operating lease under the regulation 842-10-25-3. Accordingly, the lease transaction will be considered as finance lease by testing the following criteria on the date of commencement under 842-10-25-2:
Accordingly, in the present situation 2, lease transaction would be considered as an operating lease since the transfer of ownership of underlying asset has not been indicated together with the option of purchase. In addition, the situation does not indicate the specialization nature of the asset for its alternative utility to the lessor while the lease 33% is not equal to or excess to 75% of the outstanding economic life of the asset.
Further, present value of the payments using discount rate 5% reflects the following value that is calculated as in the following table:
Year | Payment $ | Discounting factor @6% | Present Value of Payment $ |
20x1 | 12,000 | 0.94 | 11,280 |
20x2 | 12,000 | 0.89 | 10,680 |
20x3 | 12,000 | 0.84 | 10,080 |
20x4 | 12,000 | 0.79 | 9,480 |
20x5 | 12,000 | 0.75 | 9,000 |
20x6 | 12,000 | 0.7 | 8,400 |
20x7 | 12,000 | 0.63 | 7,560 |
20x8 | 12,000 | 0.56 | 6,720 |
20x9 | 12,000 | 0.39 | 4,680 |
20x10 | 12,000 | 0.31 | 3,720 |
Total | 120,000 |
| 81,600 |
The present of all the payments amounted to $81,600 while measuring $81,600/$140,000 reflects 58%, which does not satisfy the 90% criteria hence the lease is to be classified as operating lease (Propheter & Hatch, 2015). In the present case, Winslow leased equipment from Queen Anne during the year 20x1 with total amount to $120,000 along with the related costs of $20,000 with the useful life 30 years. Further, Winslow tested the asset for impairment during the year 31 December 20x2 as the estimated future cash flows reflected lower value than the fair value of asset amounted to $60,000.
Journal entry |
|
|
| |
Impairment of underlying asset |
|
|
| |
Date | Particulars |
| Debit | Credit |
31.12.20x2 | Impairment A/c | Dr. | 360 |
|
| To Asset A/c |
|
| 360 |
| (Being impairment for the asset has been recognized for the year 20x2) |
|
|
|
31.12.20x2 | Profit & Loss A/c | Dr. | 360 |
|
| To Impairment A/c |
|
| 360 |
| (Being impaired value for the asset has been transferred to profit and loss A/c for the year 20x2) |
|
|
|
Entries to be recorded for the lease during 20x3 |
| |||
Date | Particulars |
| Debit | Credit |
20x3 | Right to use the asset | Dr. | 59,640 |
|
| To Lease Liability |
|
| 59,640 |
| (Being the asset acquired on lease during the year 20x1 recognized in the current year) |
|
|
|
20x3 | Depreciation expenses | Dr. | 4,667 |
|
| To Leasehold asset |
|
| 4,667 |
| (Being depreciation has been recognized for the leased asset as per the economic life 3 years |
|
|
|
20x3 | Interest expenses | Dr. | 4,896 |
|
| Lease liability | Dr. | 7,104 |
|
| Amortization expenses | Dr. | 10,200 |
|
| To right to use the asset |
|
| 10,200 |
| To cash |
|
| 12,000 |
| (Being interest amount and lease liability as well as the amortization expenses for remaining 8 years recognized against the right to use the asset for the current year) |
|
|
|
Ajupov, A. A., Mishina, M. S., & Ivanov, M. E. (2014). Method of valuation of financial factors influencing the implementation of liquidity risk for leasing companies. Mediterranean Journal of Social Sciences, 5(24), 154.
Bohušová, H. (2015). Is Capitalization of Operating Lease Way to Increase of Comparability of Financial Statements Prepared in Accordance with IFRS and US GAAP?. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(2), 507-514.
Buchman, T. A., Harris, P., & Liu, M. (2016). GAAP vs. IFRS Treatment of Leases and the Impact on Financial Ratios.
Fasb.org. (2017). FASB: Financial Accounting Standards Board. Retrieved 5 March 2017, from http://www.fasb.org
Fitó, M. À., Moya, S., & Orgaz, N. (2013). Considering the effects of operating lease capitalization on key financial ratios. Spanish Journal of Finance and Accounting/Revista Española de Financiación y Contabilidad, 42(159), 341-369.
Penner, J. W., Kreuze, J. G., & Langsam, S. A. (2016). Impairment Analysis: Comparison of Impairment of Long-Lived Assets between Us Gaap and Ifrs. Academy of Educational Leadership Journal, 22(1), 97.
Propheter, G., & Hatch, M. E. (2015). Evaluating lease-purchase financing for professional sports facilities. Urban Affairs Review, 51(6), 905-925.
Samarathunga, S. M. D. S. S., & Perera, H. A. P. L. (2017). Improper Recognition of Incremental Rent Expense under the Operating Lease. Journal of Case Studies in Accounting, 3.
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