E5-19 – Capital Assets
The City of Rochester signed a 30-year agreement with East Coast Real Estate, Inc. to lease a newly constructed building for city services. The city agrees to make an initial payment of $1,000,000 and annual payments of $809,375 for the next 29 years. Using an assumed borrowing rate of 6 percent, the present value of the lease payments is approximately $12,000,000. At the time the lease agreement is signed, the building had an appraised market value of $13 million and an estimated life of 40 years.
a. Using the criteria presented in this chapter, determine whether the city should consider this lease agreement a capital lease. Explain your decision.
I would suggest that Rochester use a capital lease in this scenario. Looking at the figures, we see a 95% of the fair value (exceeding the 90% of the fair value). Also the lease agreement has around 75% of estimated useful life on the building.
b. Provide the 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.
c. Which financial statement(s) prepared at the end of the first year would show both the asset and the liability related to this capital lease?
E5-20 – Asset Impairment
Asset Impairment. On July 20, 2017, the building occupied by Sunshine City’s Culture and Recreation Department suffered severe structural damage as a result of a hurricane. It had been 48 years since a hurricane had hit the Sunshine City area, although hurricanes in Sunshine City’s geographic area are not uncommon. The building had been purchased in 2007 at a cost of $2,000,000 and had accumulated depreciation of $500,000 as of July 2017. Based on a restoration cost analysis, city engineers estimate the impairment loss at $230,000; however, the city expects during the next fiscal year to receive insurance recoveries of $120,000 for the damage.
a. Should the estimated impairment loss be reported as an extraordinary item? As a special item? Explain.
b. Record the estimated impairment loss in the journal for governmental activities at the government-wide level.
c. How should the insurance recovery be reported in the following fiscal year? (You need not provide the journal entry or entries here.)