Question

MSG is a manufacture company which produce automobile. At the beginning of 2010, MSG leases ten automobile to FD under a six-year non-cancellable lease agreement. Information about the lease and the automobile is:
1. Equal annual payments that are due on January 1 each year provide MSG 7% return on net investment (present value factor for 6 periods at 7% is 5.1002).
2. Titles to the automobile pass to FD at the end of the lease.
3. The fair value of each automobile is $35,000. The cost of each car to MSG is $32,000. Each car has an expected useful life of 8 years. No residual value guarantee.
4. Collectability of the lease payments is probable.

a)What type of lease is this for the lessor? Explain.
b)Calculate the annual lease payment for company.
c)Prepare a lease amortization table with dates for MSG for the first three years.
d)Find out the journal entries for the lessor in 2010 to record the lease agreement, the receipt of the lease rentals, and the recognition of revenue.

Answer 1

a) Financial Lease:

Financial lease is a lease which substantially all the risk & reward incidental to the ownership is transferred.

Circumstances where the lease can be treated as Financial lease:

1. Option to purchase the asset at lessor than the fair value at the end of the period.

2. Transfer of ownership at the last day

3. Lease period covers Major part of life of asset.

Operating Lease:

Operating lease is a lease other than Financial lease.

Therefore from the above

Lease period = 6yrs

Life of asset = 8 yrs

% of lease period = 6/8

= 75%

Automobile pass to FD at the end of lease period

This lease is a Financial lease.

b.

Fair Value of Automobile = $35,000

Fair Value of 10 Automobiles = $35,000x10

= $350,000

Calculation of Annual lease payment for the company

Annual lease payments = Fair value of Automobile/PVAF(7%,6)

= $350,000/5.1002

= $68,625

Annual lease payment is $68,625

c.

Amortization Table

Year	PMT Number	Beginning Balance	Schedule Payment	Principal	Interest	Ending Balance	Cumulative Interest
2010	1	$        3,50,000.00	$           -68,624.79	$-68,624.79	$                -	$   2,81,375.21	$                             -
2011	2	$        2,81,375.21	$           -68,624.79	$-48,928.53	$-15,834.40	$   2,32,446.68	$               15,834.40
2012	3	$        2,32,446.68	$           -68,624.79	$-52,353.53	$-10,806.29	$   1,80,093.15	$               26,640.69
2013	4	$        1,80,093.15	$           -68,624.79	$-56,018.27	$   -6,486.71	$   1,24,074.87	$               33,127.40
2014	5	$        1,24,074.87	$           -68,624.79	$-59,939.55	$   -3,078.91	$      64,135.32	$               36,206.32
2015	6	$           64,135.32	$           -68,624.79	$-64,135.32	$      -822.67	$                0.00	$               37,028.98

d.

Journal Entries for the Lessor in 2010

Lease Receivable Dr $350,000

To Sales $350,000

Lease Receivable Dr $37,028.98

To Finance Income $37,028.98

On receipt of first installment

Bank Dr $68,624.79

To Lease receivable $68,624.79

Sales Dr   $350,000

Finance Income Dr $37,028.98

To Profit and Loss $ 387,028.98