Trost Leasing Company buys equipment for leasing to various manufacturing compan

Question

Trost Leasing Company buys equipment for leasing to various manufacturing companies. On October 1, 2007, Trost leases a press to Shumway Shoe Company. The cost of the machine to Trost was $196,110, which approximated its fair market value on the lease date. The lease payments stipulated in the lease are $33,000 per year in advance for the 10-year period of the lease. The payments include executory costs of $3,000 per year. The expected economic life of the equipment is also 10 years. The title to the equipment remains in the hands of Trost Leasing Company at the end of the lease term, although only nominal residual value is expected at that time. Shumway’s incremental borrowing rate is 10%, and it uses the straight-line method of depreciation on all owned equipment. Both Shumway and Trost have fiscal years ending September 30, and lease payments are made on this date. Instructions: 1. Prepare the entries to record the lease and the first lease payment on the books of the lessor and lessee, assuming the lease meets the criteria of a direct financing lease for the lessor and a capital lease for the lessee. 2. Compute the implicit rate of interest of the lessor. 3. Give all entries required to account for the lease on both the lessee and lessor's books for the fiscal years 2008, 2009, and 2010.

Explanation / Answer

1) PV of the lease payments discounted at the incremental borrowing rate of the lessee:

    30,000 * PVIFAD(10,10) =30000*6.7591 = $202,773

The entries to be passed in the books of the lessee are:

The entries in the books of the lessor are:

The implicit rate of the lessor being 11%, the amortization schedule should relate to it.

The implicit rate is given by

196110 = 30000*PVIFAD(i,10)

6.537 = PVIFAD(i,10); from the annuity factor tables for annuity due the relevant interest rate is 11%

The amortization table for the lessor based on 11% is given below:

2) The implicit rate of interest of the lessor = 11%

Calculations:

196,110 = 30,000*PVIFAD(i,10)

37 = PVIFAD(i,10)

From the anuuity due present value tables this factor is realted to the interest rate of 11%.

3) Entries of 2008, 2009 & 2010, in the books of the lessee and lessor are given below:

Books of Lessee Date Account Title & Explanations Debit Credit 10-01-2007 Leased Equipment under capital lease 2,02,773 Obligations under capital lease 2,02,773 (initial entry to record capital lease) 10-01-2007 Obligations under capital lease 30,000 Property tax Expense 3,000 Cash 33,000 (entry to record the first payment on signing of the lease)

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