On December 31, 2011, Xu Ltd., which uses private enterprise GAAP, entered into an eight-year lease agreement for a conveyor machine. Annual lease payments are $28,500 at the beginning of each lease year, which ends December 31, and Xu made the first payment on January 1, 2012. At the end of the lease, the machine will revert to the lessor. However, conveyor machines are only expected to last for eight years and have no residual value. At the time of the lease agreement, conveyor machines could be purchased for approximately $166,000 cash. Equivalent financing for the machine could have been obtained from Xu’s bank at 10.5%. Xu’s fiscal year coincides with the calendar year and Xu uses straight-line depreciation for its conveyor machines.
Instructions
(a) Calculate the present value of the minimum lease payments using a financial calculator or work sheet functions.
(b) Explain why this is a capital lease to Xu Ltd. Document your calculations in arriving at your explanation.
(c) Prepare an amortization schedule for the term of the lease to be used by Xu Ltd. Use a computer spreadsheet.
(d) Prepare the journal entries on Xu Ltd.’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2012 and 2010 as well as any adjusting journal entries at its fiscal year ends of December 31, 2012, and 2010.
(e) Prepare a partial comparative balance sheet at December 31, 2010, and 2012, for all of the accounts related to this lease for Xu Ltd. Be specific about the classifications that should be used.
(f) Provide Xu Ltd.’s required note disclosure concerning the lease for the fiscal year ending December 31, 2010.
(g) What is the significance of the difference between the amount of the present value of the minimum lease payments calculated in part (a) and the approximate selling price of the machine of $166,000?