Your employer, Wagner Inc., is a large Canadian public company that uses IFRS. You are working on a project to determine the effect of the proposed contract-based approach on the corporate accounting for leases. To get started on the project, you have collected the following information with respect to a lease for a fleet of trucks used by Wagner to transport completed products to warehouses across the country. The trucks have an economic life of eight years. The lease term is from July 1, 2011, to June 30, 2018, and the company intends to lease the equipment for this period of time, so the lease term is seven years. The lease payment per year is $545,000, payable in advance, with no other payments required, and no renewal option or bargain purchase option available. The expected value of the fleet of trucks at June 30, 2018, is $450,000; this value is guaranteed by Wagner. The leased trucks must be returned to the lessor at the end of the lease. Wagner’s management is confident that with an aggressive maintenance program, Wagner has every reason to believe that the asset’s residual value will be more than the guaranteed amount at the end of the lease term. Wagner’s incremental borrowing rate is 8%, and the rate implicit in the lease is not known. At the time the lease was signed, the fair value of the leased trucks was $3,064,470.
(a) Based on the original information:
1. Using time value of money tables, a financial calculator, or computer spreadsheet functions, determine the contractual obligations and rights under the lease at July 1, 2011.
2. Prepare an amortization schedule for the obligation over the term of the lease.
3. Prepare the journal entries and any year-end (December 31) adjusting journal entries made by Wagner Inc. in 2011 and up to and including July 1, 2012.
(b) Immediately after the July 1, 2012 leased payments, based on the feedback of the staff in operations, management reassesses its expectations for the guaranteed residual value. Management now estimates the fleet of trucks to have a value of $400,000 with a 60% probability and $300,000 with a 40% probability.
1. Calculate the probability-weighted expected value of the residual at the end of the lease term. Also calculate the present value at July 1, 2012, of any additional cash flows related to the residual value guarantee.
2. Prepare any necessary entry to implement the revision to the contractual lease rights and obligation at July 1, 2012.
3. Revise the amortization schedule effective January 1, 2013, for the lease, including any liability related to the residual value guarantee.
4. Prepare the year-end adjusting journal entries made by Wagner Inc. for fiscal year 2012.