Question

1. Stark Industries both sells and leases equipment it manufactures to customers. The most popular piece of equipment is the arc reactor; costs to manufacture each unit total $650,000. The fair value of each arc reactor is $950,000.
2. Standard lease terms provide for seven equal annual payments. Each annual payment includes $3,750 in executory costs. The first payment is due when the lease is signed and subsequent payments are due January 1 each year thereafter. Stark uses an implicit rate of interest of 7% per year in all its lease computations. The estimated economic life of the arc reactor is eight years.
3. Wayne Enterprises agrees to lease one of the arc reactors beginning January 1, 2013.
4. Wayne Enterprises’s incremental borrowing rate is determined to be 10%. Because the equipment is very specialized, Wayne is required to guarantee a salvage value of $50,000 upon expiration of the seven-year lease.  
5. There are no important uncertainties; and collectibility is reasonably predictable and assured.  
6. Both the lessee and the lessor report financial results on a calendar‐year basis. Wayne Enterprises is not aware of lessor Stark Industries implicit interest rate.

1. Compute the annual lessee payment Wayne Enterprises will make to the Stark Industries.
2. Prepare Stark Industries’ amortization table.
3. Prepare all journal entries Stark Industries should record for the year ended 12/31/13.
4. Prepare Wayne Enterprises’ amortization table.
5. Prepare all journal entries Wayne Enterprises should record for the year ended 12/31/13.

Answer 1

Fair value of lease asset Less: Present Value of the residual value (50000 x 0.0.62275) Amount to be recovered through periodic lease payments n= Present Value of Annuity factor @7% n=7 years Lease payment at the beginning of each year Add: Executory cost Lease payments including executory costs 950,000 -31,138 918,863 7% 7 5.76654 159,343.82 3,750 163,094

1 4 6 7 0 6 Lessor Workings: Year Year for discounting Annual Lease Instalments paid at the beginning of the year PV factor @7% Present Value of Min lease payments Lease recelvable Rounded off 159,344 1.00000 159,344 950,002 950,000 2 1 159,344 0.93458 148,920 3 2. 159,344 0.87344 139,177 3 159,344 0.81630 130,072 5 4 159,344 0.76290 121,563 5 159,344 0.71299 113,611 159,344 0.66634 106,177 7 Total 7 50,000 residual value 0.62275 31,138 950,002 Calculate the present value of lease liability and lease receivable on lease signing date. 1. Lease recoverable amount 950,000 2. Sales Price 918,862 Initial PV less PV of residual value 3. Cost of Sales 618,863 Cost less PV of residual value Amortisation Schedule for Lessor Repayment Schedule Annual Payment Reduction in Accounts Receivable Interest Income Year Initial PV 0 1 159,344 159,344 159,344 159,344 159,344 159,344 2 3 55,346 48,066 40,277 31,942 23,024 Lease receivable 950,000 790,656 686,658 575, 380 456,313 328,911 192,591 159,344 103,998 111.278 119,067 127,402 136,320 4 5 6 7 159,344 50,000 1,165,407 13,481 3,271 215,407 145,862 46,729 950,000 46,729 (0) Debit Credit Lessor Books General Journal Jan 1, 2013 1... To record lease Lease receivable Cost of Goods Sold Sales Revenue Equipment Inventory 950,000 618,863 918,862 650,000 163,094 3,750 159,344 Jan 1, 2013 Cash Maintenance fee payable Lease receivable (to record lease payment) 31-Dec-13 Lease receivable Lease Revenue 55,346 55,346

Lessee Books *under ASC 842 For a lessee, the discount rate for the lease is the rate implicit in the lease unless that rate cannot be readily determined. In that case, the lessee is required to use its incremental borrowing rate 6 0 5 The annual executory costs (other than maintenance) are considered part of the annual payments to the lessor similar to the rental payments, as they do not transfer a separate good or service to the lessee, but rather are part of the payment to use the leased asset and are attributable to the lease component. Workings: Year 1 2 3 4 5 7 7 Year for discounting 1 2 3 4 6 7 Annual Lease Installments pald at the beginning of the year 163,094 163,094 163,094 163,094 163,094 163,094 163,094 50,000 PV factor @10% 1.00000 0.90909 0.82645 0.75131 0.68301 0.62092 0.56447 0.51316 Present Value 163,094 148,267 134,789 122,534 111,395 101,268 92,062 25,658 899,066 Present Value of Min lease payments 899,066 Amortisation = (Present value-SV)/7 years 121,295 121,295 121,295 121,295 121,295 121,295 121,295 849,066 Repayment Schedule Finance Charges Year - 1 Reduction Annual in Principal Outstanding Payment Amount Liability 899,066 163,094 163,094 735,972 163,094 89,497 646,476 163,094 98.446 548,029 163,094 108,291 439,738 163,094 119,120 320,618 163,094 131,032 189,586 163,094 144,135 45,451 50,000 45,451 0.00 2 3 73,597 64,648 54,803 43,974 32,062 18,959 4,549 4 5 6 7 8 292,591 1,191,657 899,066 Debit Credit Lessee Books General Journal Right-of-Use Asset Lease Liability (To record the lease.) 09.06 Jan 1, 2013 899,066 899,066 Jan 1, 2013 163,094 Lease Liability Cash (to record lease payment) 163,094 31-Dec-13 73,597 Interest Expense Lease Liability (to record Interst expense) 73,597 31-Dec-13 121,295 Amortization Expense Right-of-Use Asset (to record amortisation of lease asset) 121,295