Problem 21-1 Glaus Leasing Company agrees to lease machinery to Jensen Corporati

Question

Problem 21-1

Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2014. The following information relates to the lease agreement.

(Assume the accounting period ends on December 31.)

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.)

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.)

Prepare the journal entries Jensen would make in 2014 and 2015 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

Date

Account Titles and Explanation

Debit

Credit

1/1/14

(To record the lease.)

(To record lease payment.)

12/31/14

(To record depreciation.)

(To record interest.)

1/1/15

12/31/15

(To record depreciation.)

(To record interest.)

Prepare the journal entries Glaus would make in 2014 and 2015. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

Date

Account Titles and Explanation

Debit

Credit

1/1/14

(To record the lease.)

(To record lease payment.)

12/31/14

1/1/15

12/31/15

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 $508,000, and the fair value of the asset on January 1, 2014, is $726,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $110,000. Jensen depreciates all of its equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2014. 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 11% rate of return on its investments. Jensen’s incremental borrowing rate is 12%, and the lessor’s implicit rate is unknown.

Explanation / Answer

Part 1)

The annual rental payment is calculated with the use of following payment:

The amount of annual rental payment can be calculated with the use of Payment (PMT) function/formula of EXCEL/Financial Calculator. The function/formula for PMT is PMT(Rate,Nper,-PV,FV,Type) where Rate = Required Return, Nper = Period, PV = Present Value, FV = Future Value (if any) and Type = 1 (indicates annuity due)

_________

Here, Rate = 11%, Nper = 7, PV = $673,017 and FV = 0

Using these values in the above function/formula for PMT, we get,

Annual Rental Payment = PMT(11%,7,673017,0,1) = $128,671

_________

Part B)

The present value is calculated with the use of following table:

Notes:

We will use the present value of $1 and present value of annuity due interest factors at 12% implicit rate for a period of 7 years.

_________

Part C)

The journal entries for the Year 2014 and 2015 are given below:

The amount of interest expense and lease liability for each year has been calculated with the use of following amortization schedule:

Total Amount to be Recovered 726,000 Less: Present Value of Guaranteed Residual Value (110,000* .48166) 52,983 Present Value of All Annual Payments $673,017

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