Reference no: EM132973225

Not Ordinary Drones (NOD) , Inc., a lessor, leased a drone to Worldz Information Network, Ltd., [WIN], a lessee, on January 1, 2019. The following information relates to the leased asset and the lease agreement:

Fair value of leased drone $Undisclosed

Lease 10 years
Useful life 15 years
Payment Due January 1
Payment frequency Annual
Annual Instalments starting January 1, 2019 $33,000
Estimated residual value at end of the lease, [as stated in the problem] $23,600
Interest rate implicit in the lease [unknown to the lessee] 7%
Interest rate incremental to the lessee 8%

Ownership of drone reverts to lessor at end of lease term

Year end for both companies December 31
Amortization method Straight line
Accounting standards used - NOD ASPE
- WIN IFRS

REQUIRED: Select the one best answer to each of the questions listed below and input it in the computer.

Problem 1: How should WIN classify the lease?

a. A capital lease because the lease term is less than the useful life of the asset.
b. A capital lease because the contract terms meet one of the criteria specified by ASPE.
c. An operating lease because the ownership rights are not acquired by the lessee.
d. An operating lease because NOD is not applying IFRS 16.
e. A capital lease because the lease term does not meet the short lease term or low value exemptions provided for under IFRS-16.

Problem 2: The journal entry prepared by WIN to record the lease contract on January 1, 2019 would be

a. DEBIT-Right of Use Assets [$260,000]; CREDIT-Obligation Under Capital Lease [$260,000].
b. DEBIT-Right of Use Assets [$250,090]; CREDIT-Obligation Under Capital Lease [$250,090].
c. DEBIT-Right of Use Assets [$250,090]; CREDIT-Cash [$250,090].
d. DEBIT-Right of Use Assets [$239,147]; CREDIT-Obligation Under Capital Lease [$239,147].
e. DEBIT-Right of Use Assets [$330,000]; CREDIT-Obligation Under Capital Lease [$330,000].

Problem 3: The journal entry prepared by WIN to record any other transaction related to the lease contract on January 1, 2019.

a. DEBIT-Cash [$33,000]; CREDIT-Obligation Under Capital Lease [$33,000].
b. DEBIT-Obligation Under Capital Lease [$33,000]; CREDIT-Cash [$33,000].
c. DEBIT-Executory Costs-Capital Lease [$33,000]; CREDIT-Cash [$33,000].
d. DEBIT-Interest Expense [$33,000]; CREDIT-Cash [$33,000].
e. No journal entry required as there was no other transaction on January 1, 2019.

Problem 4:  Assume for this Question only that at the time of entering into this lease contract, NOD was aware that WIN was operating under severe financial difficulties and thus determined that the credit risk associated with this lease was not normal when compared with the risk of collection of other similar receivables. How should NOD classify this lease?

a. Classify as a finance type lease.
b. Classify as a capital, manufacturer/dealer type lease.
c. Classify as a direct sales capital lease.
d. Classify as an operating lease.
e. None of the above.

Problem 5: Regardless of your answer in [4] above, assume that NOD classifies the lease as a capital lease. Determine the fair value of the drone leased.

a. $330,000.
b. $353,600.
c. $495,000.
d. $518,600.
e. None of the above.

Problem 6: Regardless of your answer in [4] above, assume that NOD classifies the lease as a capital lease. The company operates at a 20% gross profitability rate and sells the drones in the market at a price of $260,000 each. Further assume that the estimated residual value amounting to $23,600 was not guaranteed. Under these assumptions, the journal entry prepared by NOD to record the lease contract on January 1, 2019 would be

a. DEBIT-Lease Receivable [$353,600]; DEBIT-Cost of Goods Sold [$196,003];
CREDIT-Sales Revenue [$248,003]; CREDIT-Inventory [$208,000]; CREDIT-Unearned Interest Revenue [$93,600].
b. DEBIT-Lease Receivable [$330,000]; DEBIT-Cost of Goods Sold [$208,000];
CREDIT-Sales Revenue [$260,000]; CREDIT-Inventory [$208,000]; CREDIT-Unearned Interest Revenue [$70,000].
c. DEBIT-Lease Receivable [$260,000]; DEBIT-Cost of Goods Sold [$208,000];
CREDIT-Sales Revenue [$260,000]; CREDIT-Inventory [$208,000].
d. DEBIT-Lease Receivable [$353,500]; DEBIT-Cost of Goods Sold [$208,000];
CREDIT-Sales Revenue [$260,000]; CREDIT-Inventory [$208,000]; CREDIT-Unearned Interest Revenue [$93,600].
e. None of the above