Lease Accounting On 1/1/20X1, Investor, Inc. (“Lessee”) signed a Lease Agreement with Developer Inc. (“Landlord'”) to lease Landlord’s newly constructed hotel located at 1001 Jefferson Ave. in Springfield, CA. The lease term is 15 years, and the estimated life of the building is 40 years. Lessee will occupy all four floors of the building. The lease includes a renewal option, exercisable at the Landlord’s option, to extend the contract for an additional five-year term. No purchase option is present in the contract. Lessee’s monthly rental payments are $50,000 per month, due on the first of each month, and the monthly rental fee will escalate by 2% on Jan. 1 of each subsequent year of the contract. Lessee must also pay a monthly supplemental rental cost based on a percentage (1%) of its sales. From experience, Lessee estimates that 1% of its sales should approximate an additional $10,000 per month. As of 1/1/20X1, the appraised value of the building is $17 million. There are no residual value guarantees present.
You are a corporate accountant for Investor, Inc. and have been asked to prepare an accounting issues memo documenting the accounting for this lease. Document all issues relevant to the initial recognition and subsequent accounting for this lease. You can assume that the arrangement is within the scope of lease accounting guidance. Support your responses with guidance from the Codification and, as needed, firm guidebooks.
a. Also include the journal entries necessary to record this lease al 12/31/X1, 12/31/X2, and 12/31/X3.
b. Lastly, describe the line items necessary to report this lease in Investor, Inc’s balance sheet, income statement, and statement of cash flows.
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