Question

The City of Clear Lake signed a lease agreement with Mountainside Builders whereby Mountainside will construct a new office building for city administrative use and lease it to the City for 30 years. The fair market value of the building is $29 million. The City has agreed to make an initial payment of $1,796,659 and annual payments in the same amount for the next 29 years. (This assumes a 5 percent discount rate.) The lease includes a funding clause, which allows Clear Lake to terminate the lease agreement if the government does not appropriate funds for the lease payments. Clear Lake does not intend to exercise this option unless there is a financial emergency. Upon completion, the building had an appraised value of $15 million and an estimated useful life of 40 years. Required a. Provide journal entries the city should make for both the capital projects fund and governmental activities at the government- wide level to record the lease at the date of inception. (If no entry is required for a transaction/event, select "No Journal Entry Required" in the first account field. Enter your answers in whole dollars, not in millions.) Fund / Governmental Activites Transaction General Journal Debit Credit 1. Record the lease at the date of inception. Capital Projects Fund Governmental Activities

Answer 1

Answer:

Explanation:

The present value of lease payments is approx $29000000

Fair Value at the time of lease agreement is $15000000

% lease payment to fair value of building =$29000000/$15000000*100=193.33%

Lease of newly constructed building is a capital lease as total lease payments exceeds 193% of the lease asset fair value.

Lease term % based on estimated useful life of building is 30/40 =75%

Lease is a capital lease as lease term is for a period 75% of estimated life of lease asset.

a) Journal Entries

Date Account Title Dr Cr

Expenditure $29000000

To Cash $1,796,659

To Other Financial Sources $27,203,341

Capital lease Agreement To record capital lease and down payment

Buildings $29000000

To Cash $1,796,659

To Capital lease obligations $27,203,341 Payable to record capital lease and lease payments payable