Question

E21-7 (L04) (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.

Thetermofthenoncancelableleaseis6years,withnorenewaloption.Theequipmentrevertstothelessoratthetermina- tion of the lease.

Equal rental payments are due on January 1 of each year, beginning in 2017.

The fair value of the equipment on January 1, 2017, is $150,000, and its cost is $120,000.

Theequipmenthasaneconomiclifeof8years,withanunguaranteedresidualvalueof$10,000.Flynndepreciatesallofits

equipment on a straight-line basis.

Bensensettheannualrentaltoensurean11%rateofreturn.Flynn’sincrementalborrowingrateis12%,andtheimplicit

rate of the lessor is unknown.

Collectibilityofleasepaymentsisreasonablypredictable,andnoimportantuncertaintiessurroundtheamountofcosts

yet to be incurred by the lessor.

Instructions

(Both the lessor and the lessee’s accounting period ends on December 31.)

(a) Discuss the nature of this lease to Bensen and Flynn.

(b) Calculate the amount of the annual rental payment.

(c) Prepare all the necessary journal entries for Flynn for 2017.

(d) Prepare all the necessary journal entries for Bensen for 2017.

Answer 1

Ans a)
This is clearly a case of capital lease because reason being is simple that it is non-cancelable, and also the term is actually 75% of the economic life of the leased property. (6/8=75%). Also, the fair value of $150,000 is actually greater than the lessor's cost of $120,000.
Also the collectability of the lease payment is actually reasonably predictable and there is no uncertainties surround the amount of costs actually that is yet to be the incurred by the lessor.
Ans b.
						Total amount to be recovered	$15000
PV of residual ($1000x.53464)	-5346
PV of annual payments	144654
Factor for PV of an annuity due	÷4.6959
Annual rent required	$30804
Ans c.
Date	Particulars	Debit     $	Credit    $
Jan-01	Leased Equipment(30804*4.60478)	1,41,846
	Lease liability		1,41,846
	Lease liability	30,804
	Cash		30,804
Dec-31	Depreciation expense- capital lease	23,641
	Accumulated depreciation- capital lease		23,641
	Interest Expense (1,41,846-30804)*0.12	13,325
	Interest Payable		13,325
Ans d.
Date	Particulars	Debit	Credit
Jan-01	Lease receivables	1,50,000
	COGS	1,14,654
	Sales		1,44,654
	Inventory		1,20,000
	Cash	30,804
	Lease receivables		30,804
Dec-31	Interest Expense (1,50,000-30,804)*0.11	13,112
	Interest Revenue		13,112