P13-10. (Loss Contingencies: Entries and Essay)
On November 24, 2014, 26 passengers on Windsor Airlines Flight No.
901 were injured upon landing when the plane skidded off the runway. Personal
injury suits for damages totaling $9,000,000 were filed on January 11, 2015,
against the airline by 18 injured passengers. The airline carries no insurance.
Legal counsel has studied each suit and advised Windsor that it can reasonably
expect to pay 60% of the damages claimed. The financial statements for the year
ended December 31, 2014, were issued February 27, 2015.
Instructions
(a) Prepare
any disclosures and journal entries required by the airline in preparation of
the December 31, 2014, financial statements.
(b) Ignoring the November 24, 2014,
accident, what liability due to the risk of loss from lack of insurance
coverage should Windsor Airlines record or disclose? During the past decade,
the company has experienced at least one accident per year and incurred average
damages of $3,200,000. Discuss fully.
Exercise 21-2
Pat Delaney Company leases an automobile with a fair value of
$8,725 from John Simon Motors, Inc., on the following terms.
1. Noncancelable term of 50 months.
2. Rental of $200 per month (at end of each month). (The present
value at 1% per month is $7,840.)
3. Estimated residual value after 50 months is $1,180. (The
present value at 1% per month is $715.) Delaney Company guarantees the residual
value of $1,180.
4. Estimated economic life of the automobile is 60 months.
5. Delaney Company’s incremental borrowing rate is 12% a year (1%
a month). Simon’s implicit rate is unknown.
What is the present value of the minimum lease payments?
The present value of the minimum lease payments $
(a) Record the lease
on Delaney Company’s books at the date of inception.
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Account Titles and Explanation
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Debit
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Credit
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(b) Record the first
month’s depreciation on Delaney Company’s books (assume straight-line).
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Account Titles and Explanation
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Debit
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Credit
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(c) Record the first
month’s lease payment.
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Account Titles and Explanation
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Debit
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Credit
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Exercise 21-4
Castle Leasing Company signs a lease agreement on January 1, 2014,
to lease electronic equipment to Jan Way Company. The term of the noncancelable
lease is 2 years, and payments are required at the end of each year. The
following information relates to this agreement:
1. Jan Way has the option to purchase the equipment for $16,000
upon termination of the lease.
2. The equipment has a cost and fair value of $160,000 to Castle
Leasing Company. The useful economic life is 2 years, with a salvage value
of $16,000.
3. Jan Way Company is required to pay $5,000 each year to the
lessor for executory costs.
4. Castle Leasing Company desires to earn a return of 10% on its
investment.
5. Collectibility of the payments is reasonably predictable, and
there are no important uncertainties surrounding the costs yet to be incurred
by the lessor.
(a) Prepare the journal entries on the books of Castle Leasing to
reflect the payments received under the lease and to recognize income for the
years 2014 and 2015.
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Date
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Account Titles and Explanation
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Debit
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Credit
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1/1/14
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|||
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12/31/14
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|||
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12/31/15
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(b) Assuming that Jan Way Company exercises its option to purchase the equipment on December 31, 2015, prepare the journal entry to reflect the sale on Castle’s books.
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Date
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Account Titles and Explanation
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Debit
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Credit
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12/31/15
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Exercise 21-8 (Essay)
The following facts pertain to a noncancelable lease agreement
between Mooney Leasing Company and Rode Company, a lessee.
Inception date: May
1, 2014
Annual lease payment due at the beginning of
each year, beginning with May 1, 2014 $21,227.65
Bargain-purchase option price at end of lease term $ 4,000.00
Lease term 5
years
Economic life of leased equipment 10
years
Lessor’s cost $65,000.00
Fair value of asset at May 1, 2014 $91,000.00
Lessor’s implicit rate 10%
Lessee’s incremental borrowing rate 10%
The collectibility of the lease payments is reasonably
predictable, and there are no important uncertainties surrounding the costs yet
to be incurred by the lessor. The lessee assumes responsibility for all
executory costs.
Discuss the nature of
this lease to Rode Company.
E21-8 The following facts pertain to a noncancelable
lease agreement between Mooney Leasing Company and Rode Company, a lessee.
Inception date: May
1, 2014
Annual lease payment due at the beginning of
each year, beginning with May 1, 2014 $21,227.60
Bargain-purchase option price at end of lease term $4,000
Lease term 5 years
Economic life of leased equipment 10 years
Lessor’s cost $65,000
Fair value of asset at May 1, 2014 $91,000
Lessor’s implicit rate 10%
Lessee’s incremental borrowing rate 10%
The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs.
Prepare a lease amortization schedule for Rode Company for the
5-year lease term.
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RODE COMPANY (Lessee)
Lease Amortization Schedule |
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Date
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Annual Lease Payment Plus
BPO |
Interest on
Liability |
Reduction of Lease
Liability |
Lease Liability
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||||
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5/1/14
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$
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|||||||
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5/1/14
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$
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$
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$
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|||||
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5/1/15
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5/1/16
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||||||||
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5/1/17
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||||||||
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5/1/18
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||||||||
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4/30/19
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||||||||
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$
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$
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$
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||||||
Exercise 21-13
On January 1, 2014, a machine was purchased for $900,000 by Young
Co. The machine is expected to have an 8-year life with no salvage value. It is
to be depreciated on a straight-line basis. The machine was leased to St. Leger
Inc. on January 1, 2014, at an annual rental of $210,000. Other relevant
information is as follows.
1. The lease term is for 3 years.
2. Young Co. incurred maintenance and other executory costs of
$25,000 in 2014 related to this lease.
3. The machine could have been sold by Young Co. for $940,000
instead of leasing it.
4. St. Leger is required to pay a rent security deposit of $35,000
and to prepay the last month’s rent of $17,500.
(a) How much should Young
Co. report as income before income tax on this lease for 2014?
Income before income tax $
(b) What amount should St. Leger Inc. report for rent expense
for 2014 on this lease?
Rent expense $
TUTORIAL PREVIEW
(b) The minimum lease
payments in the case of a guaranteed residual value by the lessee include the
guaranteed residual value. The present value therefore is:
Monthly payment of $200
for 50 months $7,840
Residual value of $1,180
715
Present value of minimum
lease payments $8,555
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