Salisbury Creamery Leases Its Ice Cream Making Equipment from Little

question 65

Essay

Salisbury Creamery leases its ice cream making equipment from Little Rock Finance Company under the following lease terms:
• The lease term is five years,non-cancellable,and requires equal rental payments of $56,926 due at the beginning of each year starting January 1,2011.
• Upon inception of the lease on January 1,2011,Little Rock purchased the equipment at its fair value of $280,000 and immediately transferred it to Salisbury Creamery.The equipment has an estimated economic life of five years,and a $20,000 residual value that is guaranteed by Salisbury Creamery.
• The lease contains no renewal options,and the equipment reverts to Little Rock Finance Company upon termination of the lease.
• Salisbury's incremental borrowing rate is 4%; the rate implicit in the lease is also 4%.
• Salisbury depreciates similar equipment that it owns on a straight-line basis.
• Both companies have December 31 year-ends.
Requirements:
a.Evaluate how the lessee should account for the lease transaction.
b.Evaluate how the lessor should account for the lease transaction.
c.Prepare the lessee's amortization schedule for this lease.
d.Prepare the journal entries on January 1,2011 for both parties.
e.Prepare the journal entries on December 31,2011 and January 1,2012 for both parties.

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Definitions:

Deferrals

Accounting transactions that involve recognition of revenues or expenses in a period different from when they are actually received or paid, to match revenues with expenses in the appropriate period.

Accruals

Accounting adjustments for revenues that have been earned or expenses that have been incurred but are not yet recorded in the accounts.

Deferred Revenue

Money received by a company for goods or services not yet delivered or performed, recorded as a liability until the transaction is completed.

Vertical Analysis

A method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities, and equity) in a balance sheet is represented as a proportion of the total account.