Kieso chapter 21 solutions

(a) Because the lease term is longer than 75% of the economic life of the asset and the present value of the minimum lease payments is more than 90% of the fair value of the asset, it is a capital lease to the lessee. Assuming collectibility of the rents is reasonably assured and no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor, the lease is a direct financing lease to the lessor.

The lessee should adopt the capital lease method and record the leased asset and lease liability at the present value of the minimum lease payments using the lessee’s incremental borrowing rate or the interest rate implicit in the lease if it is lower than the incremental rate and is known to the lessee. The lessee’s depreciation depends on whether ownership transfers to the lessee or if there is a bargain purchase option. If one of these conditions is fulfilled, amortization would be over the economic life of the asset. Otherwise, it would be depreciated over the lease term. Because both the economic life of the asset and the lease term are three years, the leased asset should be depreciated over this period.

21-6 Copyright © 2011 John Wiley & Sons, Inc. Kieso,     Intermediate Accounting, 14/e, Solutions Manual (    For Instructor Use Only)

EXERCISE 21-5 (Continued)

The lessor should adopt the direct-financing lease method and replace the asset cost of $75,000 with Lease Receivable of $75,000. (See schedule below.) Interest would be recognized annually at a constant rate relative to the unrecovered net investment.

Cost (fair value of leased asset)............................................... $75,000

Amount to be recovered by lessor through lease payments................................................................................. $75,000

Three annual lease payments: $75,000 ÷ 2.53130*................ $29,629

*Present value of an ordinary annuity of 1 for 3 periods at 9%.