Question & Answer: Culver Corporation leased equipment to Splish Brothers, Inc. on January 1, 2017. The lease agreement called for annual rental payments of…..

Culver Corporation leased equipment to Splish Brothers, Inc. on January 1, 2017. The lease agreement called for annual rental payments of $1,135 at the beginning of each year of the 3-year lease. The equipment has an economic useful life of 7 years, a fair value of $9,500, a book value of $7,500, and Culver expects a residual value of $7,000 at the end of the lease term. Culver set the lease payments with the intent of earning a 4% return, though Splish Brothers is unaware of the rate implicit in the lease and has an incremental borrowing rate of 6%. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

1. Prepare all necessary journal entries for Splish Brothers in 2017

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a. 1/1/17 to record the lease:

b. 1/1/17 to record lease liability:

c. 12/31/17

How would the measurement of the lease liability and right-of-use asset be affected if, as a result of the lease contract, Splish Brothers was also required to pay $600 in commissions, prepay $800 in addition to the first rental payment, and pay $200 of insurance each year?

lease liability:

right of use of asset:

Suppose, instead of a 3-year lease term, Splish Brothers and Culver agree to a one-year lease with a payment of $1,135 at the start of the lease. Prepare necessary journal entry for Splish Brothers in 2017.

1/1/17:

Expert Answer

 

Step 1: Capital Lease requirement Test:

a) Lessor will transfer the ownership at the end of the term of lease – No

b) Purchasing bargaining – No

c) 75% or more of total life will be the lease life. If total life of asset will be 6 and lease agreement is of 5 years, then it is more than 75% life of total lease and acceptable as capital lease.

Lease life = 3 years

Life of Equipment = 7years

Less than 45%

d) 90% or more of fair value of asset will be the present value of asset for lease.

PV of lease payments    = $1,135 * (PVAF @6%, 2 years)

= $1,135 * 2.8334

= $3,216

Since the non of the above condition of Capital Lease test satisfied, hence lease will be trated as operating lease and accounted in accord.

1. Journal Entries in Books of Splish Brothers in 2017:

Journal Entry:

12/31/2017         Lease Rent          Dr           $1,135

Cash                      Cr            $1,135

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