Rhone-Metro Industries manufactures equipment that is sold or leased. On Decembe

Question

Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2018 Rhone-Metro leased equipment to Western Soya Co. for a noncancelable stated lease term of four years ending December 31, 2022, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost $300,000 to manufacture and has an expected usefu life of six years. Its normal sales price is $365,760. The expected residual value of $25,000 at December 31, 2022, is not guaranteed. Western Soya Co. is reasonably certain to exercise a purchase option on December 30, 2021, at an option price of $10,000. Equal payments under the lease are $134,960 (including $4,000 annual maintenance costs) and are due on December 31 of each year. The first payment was made on December 31, 2018. Western Soya's incremental borrowing rate is 12%. Western Soya knows the interest rate implicit in the lease payments is 10%. Both companies use straight-line depreciation Hint: A lease term ends for accounting purposes when an option becomes exercisable if it's expected to be exercised (i.e., a BPO). Required: 1. Show how Rhone-Metro calculated the $134,960 annual lease payments. 2. How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone- Metro Industries (the lessor)? Why? 3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2018 . Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and the lessor 5. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31 2019 (the second rent payment and depreciation). 6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 30 2021, assuming the purchase option is exercised on that date

Explanation / Answer

Requirement 1 Amount to be recovered (fair value) $365,760.00 Less: Present value of the BPO price = $10,000 x PV( n=3, i=10% ) = ($10,000 x .75131*) -$7,513.15 Amount to be recovered through periodic lease payments $358,246.85 Lease payments at the beginning of each of three years: $358,247 / PVAD(3,10%) = ($358,247 ÷ 2.73554) $130,960

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