• The lease is noncancelable and has a term of 8 years — January 2016 Ballieu Company leases specialty equipment with economic life Anderson contains

On January 1, 2016, Ballieu Company leases specialty equipment with an economic life of 8 years to Anderson Company. The lease contains the following terms and provisions:

• The lease is noncancelable and has a term of 8 years.

• The annual rentals are $35,000, payable at the beginning of each year.

• The interest rate implicit in the lease is 14%.

• Anderson agrees to pay all executory costs and is given an option to buy the equipment for $1 at the end of the lease term, December 31, 2024.

• The cost of the equipment to the lessor is $150,000, and the fair retail value is approximately $185,100.

• The lessor incurs no material initial direct costs.

• The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor.

• The lessor estimates that the fair value is expected to be significantly greater than $1 at the end of the lease term.

The lessor calculates that the present value on January 1, 2016 of 8 annual payments in advance of $35,000 discounted at 14% is $185,090.68 (the $1 purchase option is ignored as immaterial).

Required:

1. Identify the classification of the lease transaction from Ballieu’s point of view. Give the reasons for your classification.

2. Prepare all the journal entries for Ballieu for the years 2016 and 2017.

3. Discuss the disclosure requirements for the lease transaction in Ballieu’s notes to the financial statements.

SOLUTION

1. Application of Criteria for Determination of Lease Classification

Capitalization Criteria Met Remarks

1. Transfer of ownership at end of lease No

2. Bargain purchase option Yes

3. Lease term is 75% or more of economic life Yes 100%

4. Present value of lease payments is 90% or Present value is $185,090.68

more of fair value Yes or 100% of fair value

This is a sales-type lease for Ballieu Company, since one or more of the capitalization criteria are met, both of the recognition criteria are met, and there is a dealer’s profit (PV of lease payments – Cost of asset = $185,090.68 – $150,000 = $35,090.68)