Mullen equipment company both leases and sell its equipment to its customers. Th
ID: 2589485 • Letter: M
Question
Mullen equipment company both leases and sell its equipment to its customers. The most popular line of equipment includes machine that costs $280,000 to manufacture. The standard lease terms provide for five annual payments of $110,000 each (excluding executory costs), with the first payment due when the lease is signed and subequent payment are due on December 31 of each year. The implicit rate of interest in the contract is 10% per year. Walton Tool Co. leases one of theses macines on January 2,2015. Initial direct cost of $20,000 are incurred by Mullen on January 2,2015, to obtain the lease. Walton's incremental borrowing rate is determined to be 12%. The equipment is very specialized, and it is assumed it will have no salvage value after five years. Assume that the lease qualifies as a capital lease and a sales-type lease for leesee and lessor,respectively. Also assume that both the lessee and lessor are on a calendar -year basis and that the lessee is aware of the lessor's implicit interest rate.
Instructions:
1. Give all entries required on Walton's book and Mullen book's for the year 2015 and 2016.
2. Prepare the balance sheet section involving lease balances for both lessee and lessors' financial statement at December 31, 2016.
3. Determine amount of expense and revenue Walton and Mullen will report for 2015 and 2016
Explanation / Answer
Solution:
1. Walton Tool Co. Books:
2016
Jan. 2 Leased Equipment...................................................... 458,689*
Obligations under Capital Leases......................... 458,689
To record capital lease (present value of
lease computed using implicit interest rate
of 10%, because it is known and is lower than
incremental borrowing rate).
*PVn = $110,000 + $110,000(PVAF @ 10%, 4)
PVn = $110,000 + $110,000(3.1699)
PVn = $458,689
2 Obligations under Capital Leases............................ 110,000
Cash.......................................................................... 110,000
To record first lease payment.
Dec. 31 Obligations under Capital Leases............................ 75,131
Interest Expense......................................................... 34,869*
Cash.......................................................................... 110,000
*Interest expense: $348,689 ´ 0.10 = $34,869
31 Amortization Expense on Leased Equipment........ 91,738*
Accumulated Amortization on Leased
Equipment............................................................... 91,738
*Amortization expense: $458,689/5 = $91,738
Mullen Equipment Company Books:
2016
Jan. 2 Deferred Initial Direct Costs...................................... 20,000
Cash.......................................................................... 20,000
To record payment of initial direct costs to
obtain lease.
2 Lease Payments Receivable...................................... 458,689
Sales.......................................................................... 458,689
Cost of Goods Sold.................................................... 300,000
Inventory................................................................... 280,000
Deferred Initial Direct Costs................................... 20,000
To record lease.
2 Cash............................................................................. 110,000
Lease Payments Receivable................................... 110,000
To record receipt of first lease payment.
Dec. 31 Cash............................................................................. 110,000
Interest Revenue [($458,689 – $110,000) ´ 0.10] 34,869
Lease Payments Receivable................................... 75,131
2. Walton Tool Co.
Balance Sheet (Partial)
December 31, 2016
Assets Liabilities
Land, buildings, and Current liabilities:
equipment: Obligations under capital
Leased equipment under leases—current portion.... $ 82,644*
capital leases...................... $458,689
Less: Accumulated Long-term liabilities:
amortization on leased Obligations under capital
equipment under capital leases, exclusive of
leases................................... 91,738 $82,644 included in
Net value................................... $366,951 current liabilities................ 190,914
*Total obligations under capital leases, Dec. 31, 2016
$348,689 – $110,000 + $34,869 = $273,558
Interest for 2009: $273,558 ´ 0.10 = $27,356
Current obligations at Dec. 31, 2008: $110,000 – $27,356 = $82,644
Mullen Equipment Company
Balance Sheet (Partial)
December 31, 2016
Current assets:
Lease payments receivable—current portion.................................... $ 82,644
Noncurrent assets:
Lease payments receivable, exclusive of
$82,644 included in current assets...................................................... 190,914
3. Walton Tool Co. expenses for 2016—leases:
Interest expense.................................................................................... $ 34,869
Amortization expense........................................................................... 91,738
Total............................................................................................................. $ 126,607
Mullen Equipment Co. revenue for 2016—leases:
Gross profit from lease:
Sales.................................................................... $ 458,689
Cost of goods sold............................................ 300,000 $ 158,689
Interest revenue....................................................... 34,869
Total............................................................................... $ 193,558
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