Assume that on December 31, 2021, Stora Enso (FIN) signs a 10-year, non-cancelable lease agreement to lease a storage building from Sheffield Storage. The following information pertains to this lease agreement.

1. The agreement requires equal rental payments of €71,830 beginning on December 31, 2021.

2. The fair value of the building on December 31, 2021, is €525,176.

3. The building has an estimated economic life of 12 years, a guaranteed residual value of €10,000, and an expected residual value of €7,000. Stora Enso depreciates similar buildings using the straight line method.

4. The lease is non-renewable. At the termination of the lease, the building reverts to the lessor.

5. Stora Enso’s incremental borrowing rate is 8% per year. The lessor’s implicit rate is not known by Stora Enso.

Instructions

a. Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2021, 2022, and 2023. Stora Enso’s fiscal year-end is December 31.

b. Use the same facts as above, except that Stora Enso incurred legal fees of €5,000 resulting from the execution of the lease, and received a lease incentive of €1,000 from Sheffield to enter the lease. How would the initial measurement of the lease liability and right-of-use asset be affected under this situation?

c. Suppose that in addition to the €71,830 annual rental payments, Stora Enso is also required to pay €5,000 annually for insurance costs on the building directly to the lessor, Sheffield Storage. How would this executory cost affect the initial measurement of the lease liability and right-of-use asset? 

d. Return to the original facts in the problem. Now suppose that, at the end of the lease term, Stora Enso has taken good care of the asset and Sheffield agrees that the fair value of the asset is actually €10,000. Record the entry for Stora Enso at the end of the lease to return the storage building to Sheffield assuming the accrual of interest on the lease liability has already been made.