Question

Problem 21-1

Monty Leasing Company agrees to lease machinery to Flounder 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 $541,000, and the fair value of the asset on January 1, 2017, is $760,000.
3.		At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $90,000. Flounder depreciates all of its 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 reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.
6.		Monty desires a 10% rate of return on its investments. Flounder’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31.)

Part 1:

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.)

My answer for Part 1 (INCORRECT): 133,805

Part 2:

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.)

My answer for Part 2 (INCORRECT): 716,561

Part 3:

Prepare the journal entries Monty 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.)

To record the lease, on 1/1/17

Answer 1

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	Part 1
	Calculation of annual rental payment:
	$760,000-($90,000*0.51316)/(5.35526)		$   133,292
	PV of $1 at 10%for 7 periods=0.51316
	PV of an annuity due at 10% for 7 periods=5.35526
	Part 2
	PV of annual payments	$133,292*5.23054	$   697,191
	PV of guranteed residual value	$90,000*0.48166	$      43,349
	Present value of minimum lease payment		$   740,541
	PV of $1 at 11%for 7 periods=0.48166
	PV of an annuity due at 11% for 7 periods=5.23054
	Part 3
Date	Account	Debit	Credit
1/1/10	Lease Receivable	$                       760,000
	Cost of Goods Sold	$                       541,000
	Sales		$   760,000
	Inventory		$   541,000
	Cash	$                       133,292
	Lease Receivable		$   133,292
12/31/10	Interest Receivable	$                         62,671
	Interest Revenue		$      62,671
	[($760,000-$133,292)*0.10]
1/1/11	Cash	$                       133,292
	Lease Receivable		$      70,622
	Interest Receivable		$      62,671
12/31/11	Interest Receivable	$                         55,609
	Interest Revenue		$      55,609
	[($760,000-$133,292-$70,622)*0.10]