Assignment Chapter 20 Due April 7th

Marshall Enterprises agrees to lease equipment to Burlington Corporation on June 30, 2020. Burlington uses IFRS 16 and Marshall uses ASPE. The following information relates to the lease agreement.

1. The lease term is five years, with no renewal option, and the equipment has an estimated economic life of six years.

2. The equipments cost is $330,000 and the assets fair value on June 30, 2020, is $435,000.

3. At the end of the lease term, the asset reverts to Marshall, the lessor. The asset is expected to have a residual value of $45,000 at this time, and this value is guaranteed by Burlington. Burlington depreciates all of its equipment on a straight-line basis.

4. The lease agreement requires equal annual rental payments, beginning on June 30, 2020.
5. Marshalls implicit rate is 11% and this is known to Burlington. Burlingtons incremental rate is 10%.

6. Marshall is uncertain about what additional costs it might have to incur in connection with this lease during the lease term, although Burlington has agreed to pay all executory costs directly to third parties.

7. Marshall incurred legal costs of $5,000 in early June 2020 in finalizing the lease agreement.

Required:

(a) Discuss the nature of this lease for both the lessee and the lessor.

(b) Using time value of money tables, a financial calculator, or computer spreadsheet functions, calculate the amount of the annual rental payment that is required assuming IFRs 16 is applied for calculating the payment. Show your work.

(c) Prepare the journal entries that Burlington would make in 2020 and 2021 related to the lease arrangement, assuming that the company has a December 31 fiscal year end and that it does not use reversing entries.

(d) From the information you have calculated and recorded, identify all balances related to this lease that would be reported on Burlingtons December 31, 2020 balance sheet and income statement, and where each amount would be reported.

(e) Prepare the journal entries that Marshall would make in 2020 and 2021related to the lease arrangement, assuming that the company has a December 31 fiscal year end and does not use reversing entries.

(f) From the information you have calculated and recorded, identify all balances related to this lease that would be reported on Marshalls December 31, 2020 balance sheet and income statement, and where each amount would be reported.

(g) Comment briefly on the December 31, 2020 reported results in parts (d) and (f) above.

Question two

Using the information from question one but assuming that the information in bullet point 6 indicates that Marshall is certain about what additional costs it might have to incur in connection with this lease during the lease term, and there are no uncertainties related to the collection of the lease payments meaning the credit risk is normal.

1. Discuss the nature of this lease for the lessor, Marshall.

2. Prepare the journal entries that Marshall would make in 2020 and 2021 related to the lease arrangement, assuming that ASPE is applied in determining the payment and the company has a December 31 fiscal year end and does not use reversing entries.

(c) From the information you have calculated and recorded, identify all balances related to this lease that would be reported on Marshalls December 31, 2020 balance sheet and income statement, and where each amount would be reported.

Question three

On January 1, 2020, Hershey Corporation sells equipment to Capital Finance Corp. for $570,000 and immediately leases the equipment back. Both Hershey and Capital use

ASPE. Other relevant information is as follows.

1. The equipments carrying value on Hersheys books on January 1, 2020, is $510,000.

2. The term of the non-cancellable lease is 9 years. Title will transfer to Hershey at the end of the lease.

3. The lease agreement requires equal rental payments of $95, 075.31 at the end of each year.

4. The incremental borrowing rate of Hershey Corporation is 10%. Hershey is aware that Capital Finance Corp. set the annual rental to ensure a rate of return of 9%, the implicit rate.

5. The equipment has a fair value of $570,000 on January 1, 2020, and an estimated economic life of 9 years, with no residual value.

6. Hershey pays executory costs of $9,750 per year directly to appropriate third parties.

Required

(a) Prepare the journal entries for both the lessee and the lessor for 2020 to reflect the sale and leaseback agreement. No uncertainties exist and collectability is reasonably certain.

(b) What is Hersheys primary objective in entering a sale-leaseback arrangement with Capital Finance Corp.? Would you consider this transaction to be a red flag to creditors, demonstrating that Hershey is in financial difficulty?