Question

Martinez Corporation leased equipment to Tamarisk, Inc. on January 1, 2020. The lease agreement called for...

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

Homework Answers

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
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