(a) Lucky Limited purchased two pieces of equipment from Great Machinery and lea

Question

(a) Lucky Limited purchased two pieces of equipment from Great Machinery and leased them to Forever Company. The details of the lease a greement are shown as below: Equipment A: The lease was entered on 1 January 2017 for a four-year period. The rental was S6,505 per quarter payable at the end of each quarter (31 March, 30 June, 30 September, and 31 December). The equipment was brand new at the inception of the lease and the remaining useful life at the date of the agreement was seven years. The fair value of the asset at the date of the contract was $70,500. The implicit interest rate was 20%. Equipment B: The lease was entered on 1 January 2017 for a six-year period. The rental was S6,300 per year payable at the beginning of each year. The remaining useful life of the equipment is estimated to be seven years. The fair value of the asset at the date of the contract was $65,000. The implicit interest rate was 12%. Lucky Limited considers the collectability of the lease payments is reasonably predictable, and there is no future cost to be incurred. Required: (Answers should be rounded to the nearest dollar.) (i) Explain how Lucky Limited should classify these TWQ leases. (ii) Prepare the appropriate entries for Lucky Limited, for the inception of these two leases for (10 marks) Equipment A and Equipment B on 1 January 2017 (5 marks) (b) Happy Limited leased a machine directly from Great Machinery (the manufacturer) on 1 January 2017. The details of the lease agreement are shown as below: Lease term Pavment Useful life of the machine ears S20,000 (every six months, beginning 1 January 2017 of machine to Great Machin 70,000 Implicit interest rate The contract specified that ownership is transferable to the lessee at the end of the lease. Depreciation follows a straight-line pattern, with no residual value Required: (Answers should be rounded to the nearest dollar.) (i) Compute the present value of the minimum lease payment (MLP). (ii) Prepare all necessary journal entries for Great Machinery, from the inception of the lease (2 marks) through the second lease payment on 1 July 2017 (8 marks)

Explanation / Answer

A. Equipment A:-

Lease rental = $6505 per quarter

Lease term(n) = 4*4 = 16

Fair value of the asset = $70500

Implicit rate = 20%

Present value annuity factor = 4.73

Present value of minimum lease payments = $6505 (pv of annuity factor) = $6505* 4.73 = $30769.

90%of the fair value = $70500*90% = $63450

Eventhough the minimum lease payments do not cover 90% of the fair value,

As the lease covers the substantial useful life of the asset.It is classified as FINANCIAL LEASE.

Equipment B:-

Lease rental = $6300 at the end of each year

Lease term(n) = 6

Fair value of the asset = $65000

Implicit rate = 12%

Present value annuity factor = 4.111

Present value of minimum lease payments = $6300 (pv of annuity factor) = $6300* 4.111 = $25899

90%of the fair value = $65000*90% = $58500

Eventhough the present value of minimum lease payments do not cover 90% of the fair value,

As the lease covers the substantial useful life of the asset.It is classified as FINANCIAL LEASE.

2.  Equipment A:-

In the books of lessor:-

Lease receivable a/c DR. $30769

To Asset a/c $30769

(Being asset given on lease and amount receivable)

In the books of lessee:-

Lease asset a/c DR. $30769

To Lease liability $30769

(Baing asset taken on lease and amount payable)

Equipment B:-

In the books of lessor:-

Lease receivable a/c DR. $25899

To Asset a/c $25899

(Being asset given on lease and amount receivable)

In the books of lessee:-

Lease asset a/c DR. $25899

To Lease liability $25899

(Baing asset taken on lease and amount payable)

B. a.Calculation of present value of minimum lease payments:-

n = 3* 2 = 6

Lease rentals = $20000

implicit interest rate = 14%

PV of minimum lease payments = (20000/1.141) + (20000/1.142) + (20000/1.143) + (20000/1.144) +

(20000/1.145) + (20000 / 1.146)

= $77780

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