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Chapter 21: Q1PC-c (page 1245)

Question: Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

  1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
  2. The cost of the machinery is \(525,000, and the fair value of the asset on January 1, 2017, is \)700,000.
  3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight-line basis.
  4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
  5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

(c) Compute the present value of the minimum lease payments.

Short Answer

Expert verified

Answer

PV of guaranteed residual value is $681,741.

Step by step solution

01

Meaning of Present value

The worth of a sum of money in the present, as opposed to the future value it will have if invested at compound interest, is referred to as present value. This must be multiplied by the value rate and the total duration to determine the present value.

02

Computing the present value of the minimum lease payments

Computation of present value of minimum lease payments

PV of annual payments

$633,575

PV of guaranteed residual value

48,166

$681,741

Working Notes:-

Calculation of PV of annual payments

PVofannualpayments=Annualrentalpayments×Presentvalue ofannuity=$121,130×5.23054=$633,575

Calculation of PV of guaranteed residual value

PVofguranteedresidualvalue=Guranteed residualvalue×Presentvalue=$100,000×0.48166=$48,166

Note:Present value of an annuity due at 11% for 7 periods

Present value of $1 at 11% for 7 periods

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Most popular questions from this chapter

(Lessor Entries; Sales-Type Lease) Crosley Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, 2017. The lease is for an 8-year period and requires equal annual payments of \(35,013 at the beginning of each year. The first payment is received on January 1, 2017. Crosley had purchased the machine during 2016 for \)160,000. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by Crosley. Crosley set the annual rental to ensure an 11% rate of return. The machine has an economic life of 10 years with no residual value and reverts to Crosley at the termination of the lease.

Instructions

  1. Compute the amount of the lease receivable.

Question: (Balance Sheet and Income Statement Disclosure—Lessee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017

\(300,383

Residual value at end of lease term

–0–

Lessor’s implicit rate

10%

Lessee’s incremental borrowing rate

10%

Annual lease payment due at the beginning of each year, beginning with October 1, 2017

\)62,700

The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to \(5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This \)5,500 is not included in the rental payment of \(62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.

Date

Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?

Receivable

Balance of Lease Liability/Receivable

10/01/17

\)300,383

10/01/17

\(62,700

\)62,700

237,683

10/01/18

\(62,700

\)23,768

38,932

198,751

10/01/19

\(62,700

19,875

42,825

155,926

10/01/20

\)62,700

15,593

47,107

108,819

10/01/21

\(62,700

10,882

51,818

57,001

10/01/22

\)62,700

5,699*

57,001

0

\(376,200

\)75,817

\(300,383

*Rounding error is \)1.

Instructions

(a) Assuming the lessee’s accounting period ends on September 30, answer the following questions with respect to this lease agreement.

(b) What items and amounts will appear on the lessee’s income statement for the year ending September 30, 2018?

(Lessee Entries, Capital Lease with Monthly Payments) Shapiro Inc. was incorporated in 2016 to operate as a computer software service firm with an accounting fiscal year ending August 31. Shapiro’s primary product is a sophisticated online inventory-control system; its customers pay a fixed fee plus a usage charge for using the system.

Shapiro has leased a large, Alpha-3 computer system from the manufacturer. The lease calls for a monthly rental of \(40,000 for the 144 months (12 years) of the lease term. The estimated useful life of the computer is 15 years.

Each scheduled monthly rental payment includes \)3,000 for full-service maintenance on the computer to be performed by the manufacturer. All rentals are payable on the first day of the month beginning with August 1, 2017, the date the computer was installed and the lease agreement was signed. The lease is noncancelable for its 12-year term, and it is secured only by the manufacturer’s chattel lien on the Alpha-3 system.

This lease is to be accounted for as a capital lease by Shapiro, and it will be depreciated by the straight-line method with no expected salvage value. Borrowed funds for this type of transaction would cost Shapiro 12% per year (1% per month). Following is a schedule of the present value of \(1 for selected periods discounted at 1% per period when payments are made at the beginning of each period.

Periods Present (months)

Present Value of \)1 per Period Discounted at 1% per Period

1

1.000

2

1.990

3

2.970

143

76.658

144

76.899

Instructions

Prepare all entries Shapiro should have made in its accounting records during August 2017 relating to this lease. Give full explanations and show supporting computations for each entry. Remember, August 31, 2017, is the end of Shapiro’s fiscal accounting period and it will be preparing financial statements on that date. Do not prepare closing entries.

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

  1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
  2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
  3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
  4. Cole Company assumes direct responsibility for all executory costs.
  5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
  6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(b) Prepare an amortization schedule that would be suitable for the lessor for the lease term.

(Accounting for an Operating Lease) On January 1, 2017, a machine was purchased for \(900,000 by Young Co. The machine is expected to have an 8-year life with no salvage value. It is to be depreciated on a straight-line basis. The machine was leased to St. Leger Inc. on January 1, 2017, at an annual rental of \)210,000. Other relevant information is as follows.

  1. The lease term is for 3 years.
  2. Young Co. incurred maintenance and other executory costs of \(25,000 in 2017 related to this lease.
  3. The machine could have been sold by Young Co. for \)940,000 instead of leasing it.
  4. St. Leger is required to pay a rent security deposit of \(35,000 and to prepay the last month’s rent of \)17,500.

Instructions

(a) How much should Young Co. report as income before income tax on this lease for 2017?
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