Nash Leasing Company agrees to lease machinery to Crane Corporation on January 1

Question

Nash Leasing Company agrees to lease machinery to Crane Corporation on January 1, 2017. 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 Crane would make in 2017 and 2018 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.)

Prepare the journal entries Nash would make in 2017 and 2018. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.)

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 $561,000, and the fair value of the asset on January 1, 2017, is $763,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $92,000. Crane depreciates all of its equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 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. Nash desires a 10% rate of return on its investments. Crane’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. Date Account Titles and Explanation Debit Credit (To record lease payment.) To record depreciation.) To record depreciation.) (To record interest.)

Explanation / Answer

Since the lease covers majority of the useful life of the asset and the asset reverts to the Lessor, this is a finance lease. Since the Fair Market Value is higher than the Cost of the asset. A profit of $202,000 is to be immediately recorded.

The fair market value of the asset which is $763,000 must equal the total present value of the lease payments.

Since the payment is at the beginning of the year. The PV factor for the 1st payment is to be 1. Hence

Let the Lease payment be x and the Residual Value be RV

$763,000 = (X) +(X)/(1+10%)1 +(X)/(1+10%)2 +(X)/(1+10%)3 +(X)/(1+10%)4 +(X)/(1+10%)5 +(X)/(1+10%)6 + RV/(1+10%)6

The following PV Values are used:

Substituting the factors:

$763,000 = X*5.35526 + $51,931.6

Answer 1: Using this we can compute the Minimum Lease Payments to be (763000-51,931.6)/5.35526 = $132,779.418

For the purpose of computing the present value of the lease payments we will use the Lessee's borrowing rate of 11%. The 1st payment is at the beggining of the period. Hence the present value of the lease payments is

132,779 + 132,779/(1+11%) + 132,779/(1+11%)2 + 132,779/(1+11%)3 + 132,779/(1+11%)4 + 132,779/(1+11%)5 + 132,779/(1+11%)6

The Following Factors are used.

Answer 2: Hence the present value of the lease payments amounts to $711,068.4

Entries in Crane:

Entries in Nash:

Payment 1    1.00000 Payment 2    0.90909 Payment 3    0.82645 Payment 4    0.75131 Payment 5    0.68301 Payment 6    0.62092 Payment 7    0.56447 Total    5.35526

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