Problem 21-1 Cullumber Leasing Company agrees to lease machinery to Riverbed Cor

Question

Problem 21-1 Cullumber Leasing Company agrees to lease machinery to Riverbed 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 2. The cost of the machinery is $575,000, and the fair value of the asset on January 1, 2017, 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual 4. The lease agreement requires equal annual rental payments, beginning on January 1, 5. The collectibility of the lease payments is reasonably predictable, and there are no 6. Cullumber desires a 9% rate of return on its investments. Riverbed's incremental borrowing estimated economic life of 9 years is $755,000 value of $103,000. Riverbed depreciates all of its equipment on a straight-line basis 2017. important uncertainties surrounding the amount of costs yet to be incurred by the lessor. rate is 10%, and the lessor's implicit rate is unknown (Assume the accounting period ends on December 31.) ere tables Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Annual rental payment INK Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Present value of minimum lease payments IN

Explanation / Answer

1 Annual rental payment=(Fair value of asset+Present value of guaranteed residual value @ lessor's rate of return on investments)/Present value annuity @ lessor's rate of return on investment for the lease term Fair value of asset=$ 755000 Present value of guaranteed residual value=Present value of $103000 @ 9% for 7thyear=103000*0.59627=$ 61415.81 Present value annuity @ lessor's rate of return on investment for the lease term=5.48592 (From present value table) Annual rental payment=(755000+61415.81)/5.48592=148820.2=$ 148820 (Note that lease payment is made in the beginning of the year.Hence,Present value of 1st year would be 1.Then consider present value of 6 years from present value table) 2 Present value of Minimum lease payments=Present value of annual rental payment+Present value of guaranteed residual value 796969.8 Present value of annual rental payment @ lessee's incremental borrowing rate(10%) for the lease term=148820*5.35526=$ 796969.8 58140.41 Present value of guaranteed residual value @ lessse's incremental borrowing rate (10%) for the last year of lease term=103000*0.56447=$58140.41 855110.2 Present value of Minimum lease payments=796969.8+58140.41=855110.2=$ 855110 (Note that lease payment is made in the beginning of the year.Hence,Present value of 1st year would be 1.Then consider present value of 6 years from present value table) 3 Journal entries in the books of Riverbed (Lessee) Date Account titles and Explanation Debit Credit 2017 Jan 1. Leased Machinery 855110 Lease liability 855110 (To record the lease) Lease liability 148820 Cash 148820 (To record lease payment) Dec 31. Depreciation expense 107444 Accumulated depreciation 107444 (855110-103000)/7 (To record depreciation) Interest expense 70629 Interest payable 70629 (Note:1) (To record interest) 2018 70629 Jan 1. Interest payable 78191 Lease liability 148820 Cash (Note:1) (To record lease payment) Dec 31. Depreciation expense 107444 Accumulated depreciation 107444 (855110-103000)/7 (To record depreciation) Interest expense 62810 Interest payable 62810 (Note:1) (To record interest) Note:1-Computation of interest expense Usually lessor's implicit rate is used for calculating interest.In this case this rate is unknown.Hence,Use Lessee's incremental borrowing rate (10%) 2017 Interest=(Lease liability-Annual lease rental)*Incremental borrowing rate=(855110-148820)*10%=$ 70629 Principal part in the Annual lease rental=Annual lease rental-Interest=148820-70629=$ 78191 2018 Ending balance of lease liability=855110-148820-78191=$ 628099 Interest=628099*10%=62809.9=$ 62810 4 Journal entries in the books of Cullumber (Lessor) Date Account titles and Explanation Debit Credit 2017 Jan 1. Lease receivable 855110 Cost of goods sold 575000 Sales 855110 Inventory 575000 (To record lease) Cash 148820 Lease receivable 148820 (To record lease payment) Dec 31. Interest receivable 70629 Interest revenue 70629 (Note:1) (To record interest) 2018 Jan 1. Cash 148820 Lease receivable 78191 Interest receivable 70629 (To record lease payment) Dec 31. Interest receivable 62810 Interest revenue 62810 (Note:1) (To record interest)

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