Question

On December 31, 20x6, the Jimmy Corporation, an entity subject to ASPE, entered into
lease-buyback arrangement with the George Finance Company to sell specialized
production equipment. The equipment has an original cost of $2,300,000, accumulated
depreciation of $850,000 and a fair value of $1,600,000. George advanced $1,600,000 to
Jimmy, took ownership of the equipment and leased the equipment back to Jimmy. The
term of the lease is 10 years and once Jimmy makes their last lease payment, the
ownership of the equipment passes to Jimmy. The equipment had 13 years remaining on
its useful life. There is no residual value expected at the end of the useful life.
The rate implicit in the lease is 8%, which is known to Jimmy. Jimmy has a December 31
year-end.
Required –
a. What is the annual lease payment as calculated by George?
c. Prepare the journal entries for this lease for the years 20x6 and 20x7.

Answer 1

Hey there !!

Let me help you with Sale and Lease back transaction :

Let us first summarise the information given in the question..

A	Original Cost		$2,300,000
B	Accumulated Depreciation		$850,000
	Carrying Amount (A-B)		$1,450,000

Fair Value		$1,600,000
Residual Value		Nil
Life of Equipment		13 Years
Lease Period		10 Years
Discount Rate		8%

	Unearned Profit on Sale and Leaseback
	Fair Value	$1,600,000
Less	Carrying Amount	$1,450,000
	Unearned Profit on Sale and Leaseback	$150,000

Let us calculate now annual lease payment :

A	Fair Value		$1,600,000
B	PVAF of 8% for 10 yrs		6.71
	Annual Lease Payment (A/B)		$ 238,450

Let us prepare Journal entries in the books of Jimmy for the same:

Cash and Bank A/c	Dr	$        1,600,000
Accumulated Depreciation	Dr	$            850,000
Equipment A/c	Cr		$        2,300,000
Unearned Profit on Sale and Leaseback	Cr		$            150,000
(to record sale of equipment)
Leased Equipment	Dr	$        1,600,000
Finance lease liabilities	Cr		$        1,600,000
(to record leaseback of equipment)
Finance lease liabilities	Dr	$            238,450
Cash and Bank A/c	Cr		$            238,450
(Record payment of financial lease)
Depreciation - machinery	Dr	$      160,000.00
Accumulated depreciation - machinery	Cr		$      160,000.00
Unearned profit on sales and leaseback	Dr	$        15,000.00
Depreciation - machinery	Cr		$        15,000.00
(to amortise unearned profit - (150,000/10)

i hope the solution is now clear to you....do let me know in case of any concerns...

all the best!

Happy studying :)