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 $12 million. The City has agreed to make an initial payment of $822,441 and annual payments in the same amount for the next 29 years. (This assumes a 6 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 $13 million and an estimated useful life of 40 years.

Required:
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.

Answer 1

The City of Clear Lake would record the lease inception with journal entries on both the capital projects fund and government-wide level, reflecting the construction of the new office building valued at $12 million with payments of $822,441 for the term of the lease.

Step-by-step explanation:

The City of Clear Lake's journal entries to record the lease agreement with Mountainside Builders would be based on the initial fair market value of the building at $12 million, the first payment of $822,441, and the annual payments of the same amount for the next 29 years with a discount rate of 6%. Upon completion, the building was appraised at $13 million with an estimated useful life of 40 years. To record the inception of the lease, the following journal entries would be made:

Capital Projects Fund:

Dr. Expenditures $822,441

Cr. Other Financing Sources - Leases $822,441

Governmental Activities at the Government-wide Level:

Dr. Capital Assets $12,000,000

Cr. Accumulated Depreciation $0 (no depreciation expense has been recorded yet)

Dr. Lease Liability $12,000,000

Cr. Capital Lease Obligation $12,000,000

The entries take into account the terms of the lease agreement, including the funding clause that allows for termination in the case of non-appropriation of funds. These entries would initially establish the asset and liability on the government-wide financial statements and recognize the first lease payment in the capital projects fund.

Answer 2

Try making discount to 5% they will have to pay just a little more for what they are buying. Try moving the payment to 822,000 so you can save the 441 dollars.