At January 1, 2018. Gem Finder leased mining equipment from Emerald Corporation
ID: 2586601 • Letter: A
Question
At January 1, 2018. Gem Finder leased mining equipment from Emerald Corporation under a nine- year lease agreement. The lease agreement specifies annual payments of $75,000 beginning January 1, 2018, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was acquired recently by Emerald at a cost of $540,000 (its fair value) and was expected to have a useful life of 12 years with no salvage value at the end of its life. (Because the lease term is only 9 years, the asset does have an expected residual value at the end of the lease term of $33,684.). Both (a) the present value of the lease payments and (b) the present value of the residual value (i.e., the residual asset) are included in the lease receivable because the two . amounts combine to allow the lessor to recover its net investment. Emerald seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. (FV of $1, of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use approprlete factor(s) from the tables provided.) What will be the effect of the lease on Emerald's earnings for the first year (ignore taxes)? 2. What will be the balances in the balance sheet accounts related to the lease at the end of the t year for Emerald (ignore taxes) 1. Effect on earnings 2. Lease receivable balance (end of year)Explanation / Answer
a) Calculation of the present value of lease payments:
it meanspresent value of payments over the lease term + any bargain purchase offer price(if it exists in the agreement)+Guaranteed residual value by lessee or any body on behalf of lessee.
lease payments per year = $ 75000.
lease term = 9 years
annuity value factor@10% for 9 years = 5.7590
present value = $75000*5.7590 = 431926.
b)Present value of guaranteed residual value = $ 33684*0.4240 = 14282.
present value of lease payments = $431926+14282 = $446208.
Fair value of the leased asset is $540000 and present value of the minimum lease payments is $ 446208.The PV of MLP covers 82.63% of fair value so it can be treated as substantial,hence the lease should be treated as a Finance lease.
Calculation of lease effect on the books of Emeralds books(Lessor).
in lessor books recognise the receiveble amount as NET INVESTMENT(NI) in lease.
NI = Gross investment in lease(GI) less unearned finance income(UFI)
UFI= GI - PV of GI
GI = total lease rentals from the lessor point of view + unguaranteed residual value
Gross investment = $75000*9 + 33684 + 0 = 708684.
UFI = $708684 - $ 446208 = $262476.
net investment = $708684-262476 = 446208.
journal entry in the books of Emerald:
REceivable from lessee a/c dr $446208
To Mining equipment a/c $446208.
Amortization of lease rentals:
1 ( 2) 3 =(2*10%) ( 4 = 2+3 ) ( 5 ) 6 = (4-5) 7
year opening balance interest total Lease rent closing balance amount to be reduced from principal
1 446208 44620 490828 $75000 $415828 $75000-44620 = 30380
2 415828 41582 457410 $75000 $382410 $75000-41582 = 33418
3 382410 38241 420651 75000 345651 36759
4 345651 34565 380216 75000 305216 40435
5 305216 30521 335737 75000 260737 44479
6 260737 26073 286811 75000 211811 48927
7 211811 21181 232992 75000 157992 53819
8 157992 15799 173791 75000 98791 59201
9 98791 9879 108671 75000 33671 65121
1.effect of the lease on Emeralds earnings for the firsr year
Bank A/c Dr $75000
To Finance income A/c 44620
To Receivable from lessee A/c 30380
finance income should be recognised in a systematic and rationale basis.
2.$415828 is the balance at the end of first year receivable balance.
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