Problem 21-1 Windsor Leasing Company agrees to lease machinery to Sheridan Corpo

Question

Problem 21-1 Windsor Leasing Company agrees to lease machinery to Sheridan Corporation on January 1, 2017. The following information relates to the lease agreement.

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 $523,000, and the fair value of the asset on January 1, 2017, is $758,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $108,000. Sheridan 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. Windsor desires a 10% rate of return on its investments. Sheridan’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31

Calculate the amount of the annual rental payment required

Compute the present value of the minimum lease payments.

$

Prepare the journal entries Sheridan would make in 2017 and 2018 related to the lease arrangement.

Prepare the journal entries Windsor would make in 2017 and 2018.

Annual rental payment

Explanation / Answer

Since the lease period covers 77.78%(=7/9) of the economic life of the assets, the lease is considered as capital lease.

1. Annual rental payments:

2. Present value of minimum lease payments:

3.

Interest in year 1: (738224.82-131193.31)*0.11 = 66,773.47

Interest in year 2: (738224.82-131193.31-131193.31+66,773.47)*0.11 = 59,687.28

4.

Interest Income in year 1 = (702574.4-131193.31)*0.1 = 57138.11

Interest income in year 2 = (702574.4-131193.31-131193.31+57138.11)*0.1 = 49,732.59

Fair value of asset    758,000.00 Less: PV of guaranteed residual value
=108000*PVF(10%,7 years) = 108000*0.5132      55,425.60 Amount to be recovered by lessor through lease payments    702,574.40 Beginning of period annual payments for 7 years to yield 10% return to investor
=702574.40/5.3553    131,192.28

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