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 involving machinery. We need to determine the gain or loss on the sale, compute the lease liability and right-of-use asset, and also record the journal entries required for this transaction.
Answer
The computations will depend on specific numeric values involved in the given transaction.
Answer for screen readers
The final answers will vary depending on the specifics of the sale price, carrying amount, lease payments, discount rate, and initial costs provided in the problem. Be sure to input those numbers into the equations provided to find the exact gain or loss, lease liability, and right-of-use asset values.
Steps to Solve
- Determine the Sale Price and Carrying Amount
Identify the sale price received from the sale of the machinery and its carrying amount (book value). The gain or loss on the sale can be calculated using the formula: $$ \text{Gain or Loss} = \text{Sale Price} - \text{Carrying Amount} $$
- Calculate Lease Liability
To compute the lease liability, find the present value of future lease payments. You can use the formula: $$ \text{Lease Liability} = \sum \left( \frac{\text{Lease Payment}}{(1 + r)^t} \right) $$ where $r$ is the discount rate and $t$ is the number of periods.
- Calculate Right-of-Use Asset
The right-of-use asset is typically recorded at the value of the lease liability plus any initial direct costs incurred. Therefore, you can calculate it as: $$ \text{Right-of-Use Asset} = \text{Lease Liability} + \text{Initial Direct Costs} $$
- Record Journal Entries
Finally, make the journal entries to record the sale and the leaseback transaction. The general journal entries required would be:
-
For sale of machinery:
- Debit Cash (for sale price)
- Credit Machinery (for carrying amount)
- Credit Gain on Sale (if applicable, for the gain calculated)
-
For lease transaction:
- Debit Right-of-Use Asset (calculated value)
- Credit Lease Liability (calculated value)
The final answers will vary depending on the specifics of the sale price, carrying amount, lease payments, discount rate, and initial costs provided in the problem. Be sure to input those numbers into the equations provided to find the exact gain or loss, lease liability, and right-of-use asset values.
More Information
In sale and leaseback transactions, the seller can access capital from the sale while still retaining the right to use the asset through leasing. It's often used by companies to improve cash flow.
Tips
- Failing to accurately calculate present values for lease payments.
- Not recording all the relevant journal entries.
- Confusing the carrying amount with the fair market value of the asset.
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