Question

Sheffield Leasing Company agrees to lease machinery to Tamarisk Corporation on January 1, 2017. The following information relates to the lease agreement.

1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.

2. The cost of the machinery is $483,000, and the fair value of the asset on January 1, 2017, is $757,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $102,000. Tamarisk estimates that the expected residual value at the end of the lease term will be 102,000. Tamarisk amortizes all of its leased equipment on a straight-line basis.

4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.

5. The collectibility of the lease payments is probable.

6. Sheffield desires a 10% rate of return on its investments. Tamarisk’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.) Click here to view factor tables Correct answer. Your answer is correct. Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Annual rental payment $ Entry field with correct answer SHOW LIST OF ACCOUNTS SHOW SOLUTION SHOW ANSWER LINK TO TEXT LINK TO TEXT Incorrect answer. Your answer is incorrect. Try again. Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Present value of minimum lease payments $ Entry field with incorrect answer SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Partially correct answer. Your answer is partially correct. Try again. Prepare the journal entries Tamarisk would make in 2017 and 2018 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.) Date Account Titles and Explanation Debit Credit Entry field with correct answer 1/1/1712/31/171/1/1812/31/18 Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer (To record the lease.) Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer (To record lease payment.) Entry field with incorrect answer 1/1/1712/31/171/1/1812/31/18 Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with incorrect answer Entry field with correct answer Entry field with correct answer (To record depreciation.) Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer (To record interest.) 1/1/18 Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with correct answer Entry field with incorrect answer 1/1/1712/31/171/1/1812/31/18 Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer (To record depreciation.) Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer (To record interest.) SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Incorrect answer. Your answer is incorrect. Try again. Prepare the journal entries Sheffield would make in 2017 and 2018. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.) Date Account Titles and Explanation Debit Credit 1/1/17 Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer (To record the lease.) Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer (To record lease payment.) Entry field with incorrect answer 1/1/1712/31/171/1/1812/31/18 Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer 1/1/1712/31/171/1/1812/31/18 Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer 1/1/1712/31/171/1/1812/31/18 Entry field with incorrect answer Entry field with incorrect answer now contains modified data Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer Entry field with incorrect answer

Answer 1

1..Annual rent calculated at LESSOR 's reqd. rate of return of 10%

757000=(Pmt.*(1-1.1^-7)/0.1*(1.1))+(102000/1.1^7)

x=131582

2..PV of minimum lease payments(MLP) for the lessee

at LESSEE's   incremental borrowing rate of 11%

(131582*(1-1.11^-7)/0.11*1.11)+(102000/1.11^7)=

737374

Testing for operating lease or a capital lease?

1. Transfer of ownership? No

2. Bargain purchase option? No

3. Length of lease term > or equal to 75% of total life? Yes, 7/9= 77.78%

4. Present value of MLP > or equal to 90% of asset’s current FMV? Yes, 737374/757000= 97.41%

As atleast 1 of the above criteria is met (here, both 3&4 are met ), the lessee Tamarisk should account this as a CAPITAL LEASE.

Preparing the Amortisation schedule,

for the lessee

Beginning amount is the PV of the minimum lease payments (cash payments plus guaranteed residual value,ie. 737374 ) &

Ending amount is the guaranteed residual value,ie. 102000

Lease Amortisation schedule			Lessee
Date	Annuity	Tow.Int.	Tow.Principal	Principal Balance
				737374
1-Jan-17	131582	0	131582	605792
1-Jan-18	131582	66637	64945	540847
1-Jan-19	131582	59493	72089	468758
1-Jan-20	131582	51563	80019	388740
1-Jan-21	131582	42761	88821	299919
1-Jan-22	131582	32991	98591	201328
1-Jan-23	131582	22146	109436	91892
31-Dec-23	102000	10108	91892	0
	1023074	285700	737374

Lessee Journal entries
1/1/2017	Leased Machinery	737374
	Lease Liability		737374
	(To record Lease liability)
1/1/2017	Lease Liability	131582
	Cash		131582
	(To record initial lease payment)
12/31/2017	Depreciation	90768
	Accumulated depn.		90768
	(737374-102000)/7
	(To record Depreciation)
	Interest expense	66637
	Interest payable		66637
	(To accrue interest expense)
1/1/2018	Interest payable	66637
	Lease Liability	64945
	Cash		131582
	(To record payment of interest & lease) amt.
12/31/2018	Depreciation	90768
	Accumulated depn.		90768
	(737374-102000)/7
	(To record Depreciation)
	Interest expense	59493
	Interest payable		59493
	(To accrue interest expense)

Sheffield Leasing Company(Lessor)

For the lessor, in addition to any one of 4 the general criteria , both the following needs to be met, namely

5..Collectibility of future payments is reasonably predictable? No.(given only probable)

6.Amounts of future unreimbursable costs to be met by the lessor known with reasonable certainty? --No.(the question is silent on this)

If only both are met, in addition ,to any 1 of the 4 general criteria, the lessor can treat this as capital lease .

So, in this case, the lessor records this as an OPERATING lease .

His PV to start with is 757000

Ending with guaranteed value 102000

Lease Amortisation schedule			Lessor
Date	Annuity	Tow.Int.	Tow.Principal	Principal Balance
				757000
1-Jan-17	131582	0	131582	625418
1-Jan-18	131582	62542	69040	556378
1-Jan-19	131582	55638	75944	480434
1-Jan-20	131582	48043	83539	396895
1-Jan-21	131582	39689	91893	305002
1-Jan-22	131582	30500	101082	203921
1-Jan-23	131582	20392	111190	92731
31-Dec-23	102000	9273	92727	4
	1023074	266078	756996

Lessor Journal entries
Date	Account Title	Debit	Credit
1/1/2017	Lease receivable	757000
	Leased Machinery		757000
	(To record Lease)
1/1/2017	Cash	131582
	Lease receivable		131582
	(To record initial lease payment)
12/31/2017	Interest receivable	62542
	Interest Income		62542
	(To accrue interest)
1/1/2018	Cash	131582
	Interest receivable		62542
	Lease receivable		69040
	(To record receipt of interest & lease amt.)
12/31/2018	Interest receivable	55638
	Interest Income		55638
	(To accrue interest)