Question

Martinez Corporation leased equipment to Tamarisk, Inc. on January 1, 2020. The lease agreement called for annual rental payments of $1,283 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 $8,500, a book value of $6,500, and Martinez expects a residual value of $6,000 at the end of the lease term. Martinez set the lease payments with the intent of earning a 7% return, though Tamarisk is unaware of the rate implicit in the lease and has an incremental borrowing rate of 9%. 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.

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(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

A. Determine the nature of the lease to both Martinez and Tamarisk.

The lease is a/an (operating/financing) lease to Tamarisk.

The lease is a/an   (operating/financing) lease to Martinez.

  

B. Prepare all necessary journal entries for Tamarisk in 2020. (Credit account titles are automatically indented when the amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,275. Record journal entries in the order presented in the problem.)

Date	Account Titles and Explanation	Debit	Credit
1/1/2012/31/20
	(To record the lease)
1/1/2012/31/20
	(To record lease payment)
1/1/2012/31/20

  

C. How would the measurement of the lease liability and right-of-use asset be affected if, as a result of the lease contract, Tamarisk was also required to pay $500 in commissions, prepay $750 in addition to the first rental payment, and pay $200 of insurance each year? (Round answers to 0 decimal places, e.g. 5,275.)

Lease liability		$
Right-of-use-asset		$

  

D. Suppose, instead of a 3-year lease term, Tamarisk and Martinez agree to a one-year lease with a payment of $1,283 at the start of the lease. Prepare necessary journal entry for Tamarisk in 2020. (Credit account titles are automatically indented when the amount is entered. Do not indent manually.)

Date	Account Titles and Explanation	Debit	Credit
1/1/20

Answer 1

A. Determine the nature of the lease to both Martinez and Tamarisk.

Answer:

i. The lease is an operating lease to Tamarisk, Inc.

ii. The lease is an operating lease to Martinez

Explanation:

The lease is an operating lease to Tamarisk, Inc. and Martinez as the criterias for the classification tests are not met.

Reasons:

a. The lease term is 42.86% of economic life of the asset.

That is 3-year lease term / 7 years of useful life = 42.86%

b. Bargain purchase is not noted.

c. Ownership is not transferred

d. Not a specialised asset.

e. 90% test =

Martinez

PV = 2.808 (n=3, rate=7%)

Annual rental payment = 1,283

$3,603÷ $8,500 = 42%

Tamarisk, Inc.

PV = 2.759 (n=3, rate=9%)

Annual rental payment = 1,283

$3,540 ÷ $8,500 = 42%

B. Prepare all necessary journal entries for Tamarisk in 2020.

Date	General Journal	Debit	Credit
01-01-20	Right-of-Use Asset	3,540
	Lease Liability		3,540
	to record the lease
01-01-20	Lease Liability	1,283
	Cash		1,283
	to record lease payment
31-12-20	Lease Expense	1,283
	Lease Liability		203
	Right-of-Use Asset		1,080
	to record lease payment

Entry #3 :

Lease Liability Interest = 3,540 - 1,283 * 9% = 203

C. How would the measurement of the lease liability and right-of-use asset be affected if, as a result of the lease contract, Tamarisk was also required to pay $500 in commissions, prepay $750 in addition to the first rental payment, and pay $200 of insurance each year?

Answer:

Lease liability	4,092
Right-of-use-asset	5,342

Calculation:

PV of annual rental payment	3,540
PV of insurance payments (200 * 2.759)	552
Lease liability	4,092

Initial measurement of lease liability	4,092
Commissions paid	500
Prepaid rent	750
Right-of-use asset	5,342

D. Suppose, instead of a 3-year lease term, Tamarisk and Martinez agree to a one-year lease with a payment of $1,283 at the start of the lease. Prepare necessary journal entry for Tamarisk in 2020.

Answer:

Date	General Journal	Debit	Credit
01-01-20	Lease Expense	1,283
	Cash		1,283
	to record payment at start of lease