Question

Glaus Leasing Company agrees to lease machinery to Jensen

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 $ 525,000, and the fair value of the

asset on January 1, 2017, is $700,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value

of $100,000. Jensen 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. Glaus desires a 5% rate of return on its investments. Jensen’s

incremental borrowing rate is 6%, and the lessor’s implicit rate is

unknown. Instructions ( Assume the accounting period ends on

December 31.)

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

( c) Compute the present value of the minimum lease payments.

( d) Prepare the journal entries Jensen would make in 2017 and

2018 related to the lease arrangement.

Answer 1

a) Annual rental Payment=(700,000/7)=100,000

b) Minimum lease payments=

Depreciation to be charged=(662,228/7) 94,604.07

Finance charge for 2017=(662,228*5%)=33,111

Finance charge for 2018=(662,228-(100,000+33111)=529,117

                                     =(529,117*5%)=26,456

Journal Entries - 2017

Right to use the asset A/c Dr 662,228

To Lease Liability 662,228

Depreciation A/c Dr 94,604

To Right to use asset A/c 94,604

Finance cost A/c Dr 33,111

To lease Liability 33,111

PlL A/c Dr 127,715

To Deprectaion 94,604

To Finance Cost 33,111

Financial year 2018

Depreciation A/c Dr 94,604

To Right to use asset A/c 94,604

Finance cost A/c Dr 26,456

To lease Liability 26456

PlL A/c Dr 121,060

To Deprectaion 94,604

To Finance Cost 26,456