Question

Exercise 15-29 (Algo) Finance lease; purchase options; lessee [LO15-2, 15-6]

Federated Fabrications leased a tooling machine on January 1, 2021, for a three-year period ending December 31, 2023. The lease agreement specified annual payments of $49,000 beginning with the first payment at the beginning of the lease, and each December 31 through 2022. The company had the option to purchase the machine on December 30, 2023, for $58,000 when its fair value was expected to be $73,000, a sufficient difference that exercise seems reasonably certain. The machine's estimated useful life was six years with no salvage value. Federated was aware that the lessor’s implicit rate of return was 10%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Calculate the amount Federated should record as a right-of-use asset and lease liability for this finance lease.
2. Prepare an amortization schedule that describes the pattern of interest expense for Federated over the lease term.
3. Prepare the appropriate entries for Federated from the beginning of the lease through the end of the lease term.

Answer 1

1. Calculate the amount Federated should record as a right-of-use asset and lease liability for this finance lease.

Year	PV @ 10%	Payment	Present Value
0	1	$49,000	$49,000
1	0.90909	$49,000	$44,545
2	0.82644	$49,000	$40,496
Total			$134,041

PVA(10%, 3 years) = 0.751314

= $58,000   0.751314

= $43,576

Right of use asset and liability = $134,041 + $43,576

= $177,617

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2. Prepare an amortization schedule that describes the pattern of interest expense for Federated over the lease term.

Lease Amortization Schedule
Date	Payments	Effective @10%	Decrease in balance	Outstanding balance
Jan. 01, 2021				$177,617
Jan. 01, 2021	$49,000	-	$49,000	$128,617
Dec. 31, 2021	$49,000	$12,862	$36,138	$92,479
Dec. 31, 2022	$49,000	$9,248	$39,752	$52,727
Dec. 31, 2023	$58,000	$5,273	$52,727	$0

________________________________________________________________

3. Prepare the appropriate entries for Federated from the beginning of the lease through the end of the lease term.

Date	Account Titles	Debit	Credit
Jan. 01, 2021	Right of use asset	$177,617
	Lease payable		$177,617
Jan. 01, 2021	Lease payable	$49,000
	Cash		$49,000
Dec. 31, 2021	Lease payable	$36,138
	Interest Expense	$12,862
	Cash		$49,000
Dec. 31, 2021	Amortization Expense	$29,602
	Right of use asset		$29,602
	[$177,617 ÷ 6 years]
Dec. 31, 2022	Lease payable	$39,752
	Interest Expense	$9,248
	Cash		$49,000
Dec. 31, 2022	Amortization Expense	$29,602
	Right of use asset		$29,602
Dec. 31, 2023	Lease payable	$52,727
	Interest Expense	$5,273
	Cash		$58,000
Dec. 31, 2023	Amortization Expense	$29,602
	Right of use asset		$29,602