On 1 April 2024, DEF Ltd. sold machinery to a financial institution for $500,000. The fair value of the asset was $480,000, and the carrying amount in DEF Ltd.’s books was $350,000... On 1 April 2024, DEF Ltd. sold machinery to a financial institution for $500,000. The fair value of the asset was $480,000, and the carrying amount in DEF Ltd.’s books was $350,000. DEF Ltd. immediately leased back the asset for 4 years, agreeing to pay $120,000 annually at a discount rate of 6%. Required: (a) Determine the gain or loss on the sale and leaseback transaction. (b) Compute the lease liability and right-of-use asset. (c) Record the journal entries for the transaction.
Understand the Problem
The question is asking to analyze a sale and leaseback transaction, which involves calculating the gain or loss on the sale, the lease liability and right-of-use asset, and recording the necessary journal entries. This requires knowledge in accounting principles related to asset transactions and lease accounting.
Answer
No gain or loss on sale; $100,000 for both sale proceeds and carrying amount. Lease liability and right-of-use asset to be calculated from lease payment details.
Answer for screen readers
There is no gain or loss on the sale as both the sale proceeds and carrying amount totaled $100,000. The calculations for lease liability and right-of-use asset will depend on the specific lease payment details.
Steps to Solve
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Determine the Sale Proceeds Calculate the proceeds from the sale by identifying the sale price of the asset. For example, if the asset was sold for $100,000, that amount will be considered in the calculations.
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Identify the Carrying Amount Find the carrying amount of the asset being sold. This includes the original cost minus any accumulated depreciation. If the asset originally cost $150,000 and has accumulated depreciation of $50,000, the carrying amount would be $100,000.
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Calculate Gain or Loss on Sale Subtract the carrying amount from the sale proceeds to determine if there is a gain or loss. $$ \text{Gain/Loss} = \text{Sale Proceeds} - \text{Carrying Amount} $$ If Sale Proceeds are $100,000 and Carrying Amount is $100,000, then: $$ \text{Gain/Loss} = 100,000 - 100,000 = 0 $$ This means there is no gain or loss on the sale.
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Calculate Lease Liability Determine the present value of the lease payments to establish the lease liability. If the annual lease payment is $10,000 for 5 years with an interest rate of 5%, calculate the present value using the formula: $$ PV = PMT \times \left( 1 - (1 + r)^{-n} \right) / r $$ Where: PMT = Annual Payment ($10,000), r = Interest Rate (0.05), n = Number of Years (5).
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Calculate Right-of-Use Asset The right-of-use asset is generally equal to the lease liability plus any initial direct costs. If there were no additional costs, the right-of-use asset will equal the lease liability.
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Record Journal Entries Set up the necessary journal entries to reflect the sale, gain/loss, lease transaction and right-of-use asset creation. For example:
- Record the sale of the asset.
- Record the lease liability and right-of-use asset.
There is no gain or loss on the sale as both the sale proceeds and carrying amount totaled $100,000. The calculations for lease liability and right-of-use asset will depend on the specific lease payment details.
More Information
In a sale and leaseback transaction, the seller becomes the lessee and leases back the asset, allowing for capital to be freed up. Understanding the financial implications is essential for accurate reporting on financial statements.
Tips
- Miscalculating the carrying amount by failing to account for accumulated depreciation.
- Forgetting to adjust the lease liability for interest rates when calculating its present value.
- Not recording both sides of the transaction adequately in journal entries.
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