On January 1, 2014, company B leased equipment to company F. The following infor
ID: 2451044 • Letter: O
Question
On January 1, 2014, company B leased equipment to company F. The following information pertains to the lease.
The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease
Equal rental payments are due on January 1 of each year, beginning in 2014
The fair value of the equipment on January 1, 2014 is $150,000, and its cost is $120,000
The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Company F depreciates all of its equipment on a straight-line basis
Company B set the annual rental to ensure an 11% rate of return. Company F’s incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
Collectibility of lease payments is reasonably predictible, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
PLEASE SHOW YOUR WORK. This question is for intermediate accounting. Authors kieso, weygandt, and warfield
1. discuss the nature of the lease to company B and company F
2. Calculate the amount of annual rental payment
3. Prepare all the necessary journal entries for company F for 2014
4. Prepare all the necessary journal entries for company B for 2014.
Explanation / Answer
1. A lease will be classified as financial lease if at the inception of lease the present value of minimum lease payments amounts to atleast substantially all of the fair value of the leased asset.
In the given case present value of ungauranteed residual value= $10000*0.5066
= $5066
P.V. of minimum lease payments= $150000-$5066
= $144934
The P.V. of lease payments being 96.62%(144934/150000) of the fair value, i.e. being substantial portion. therefore the lease will be classified as financial lease.
2. Calculation of Annual lease rentals
PVAF@12%(0-5)=4.605
Annual lease rentals= 144934/4.605
= $31,473
3.Jornal entries in the books of Company F for 2014
1. Machine on lease A/c Dr. $150000
To Company B $150000
2. Company A/c Dr. $31473
To BankA/c $31473
3. Depreciation A/c Dr $25000
To Machine on lease $25000
4 Profit and loss A/c Dr. $25000
To Depreciation $25000
4. Jornal Entries in the books of B for 2014
1. Bank A/c Dr. $31473
To Lease rentA/c $31473
2. Lease rent A/c Dr $31473
To Profit and loss A/c $31473
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