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E21-7 (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2014, Bensen Compa

ID: 2566345 • Letter: E

Question

E21-7 (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2014, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this 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 1. 2. Equal rental payments are due on January 1 of each year, beginning in 2014 3. The fair value of the equipment on January 1, 2014, is $150,000, and its cost is $120,000. 4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000 Flynn depreciates all of its equipment on a straight-line basis 5. Bensen set the annual rental to ensure an 11% rate of return. Flynn's incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor. 6. Instructions (Both the lessor and the lessee's accounting period ends on December 31.) (a) Discuss the nature of this lease to Bensen and Flynn (b) Calculate the amount of the annual rental payment. (c) Prepare all the necessary journal entries for Flynn for 2014 (d) Prepare all the necessary journal entries for Bensen for 2014.

Explanation / Answer

Ans a)

This is clearly a case of capital lease because reason being is simple that it is non-cancelable, and also the term is actually 75% of the economic life of the leased property. (6/8=75%). Also, the fair value of $150,000 is actually greater than the lessor's cost of $120,000.

Also the collectability of the lease payment is actually reasonably predictable and there is no uncertainties surround the amount of costs actually that is yet to be the incurred by the lessor.

Ans b.

Total amount to be recovered

$15000

PV of residual ($1000x.53464)

-5346

PV of annual payments

144654

Factor for PV of an annuity due

÷4.6959

Annual rent required

$30804

Ans c.

Date

Particulars

Debit

Credit

Jan 1

Leased Equipment

141846 (30804*4.60478)

                   Lease liability

141846

Lease liability

30804

                    Cash

30804

Dec 31

Depreciation expense- capital lease

23641

                    Accumulated depreciation- capital lease

23641

Interest Expense

13325 (141846-30804)*0.12

                     Interest Payable

13325

Ans d.

Date

Particulars

Debit

Credit

Jan 1

Lease receivables

150000

COGS

114654

                Sales

144654

                Inventory

120000

Cash

30804

               Lease receivables

30804

                   

Dec 31

Interest Expense

13112 (150000-30804)*0.11

                         Interest Revenue

13112

                     

Total amount to be recovered

$15000

PV of residual ($1000x.53464)

-5346

PV of annual payments

144654

Factor for PV of an annuity due

÷4.6959

Annual rent required

$30804