Question

P21-6 (Lessee-Lessor Entries, Finance Lease with a Guaranteed Residual Value) (LO 2, 4) Glaus Leasing Company agrees to lease equipment 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 $50,000. Jensen estimates that the expected residual value at the end of the lease term will be $50,000. Jensen amortizes all of its leased 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 probable. 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.)

(a) Discuss the nature of this lease for both the lessee and the lessor.

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

(c) Compute the value of the lease liability to the lessee.

(d) Prepare the journal entries Jensen would make in 2017 and 2018 related to the lease arrangement.

(e) Prepare the journal entries Glaus would make in 2017 and 2018 related to the lease arrangement.

(f) Suppose Jensen expects the residual value at the end of the lease term to be $40,000 but still guarantees a residual of $50,000. Compute the value of the lease liability at lease commencement.

Answer 1

	Glaus Leasing Company
a)	This lease is a capital lease to Jenson because lease term is greater than 75% of economics life of the leased assets.
	Lease Term	7	Years
	Economic life	9	Years
	Lease Ternm=(7/9)*100	78%
	This lease is a capital lease to Glause lease because
1)	Collectibility of lease payment is reasonably predictable.
2)	Lease term is > 75% of economic life
b)	Annual Rental=($700000-$50000*.711)/5.786	$       1,14,838
	Present Value of $1 at 5% for 7 years	0.711
	Present Value of annuity at 5% for 7 years	5.786
c)	Present Value of minimum lease payment
	P.V of annual payment=($114837*5.786)	$       6,41,023
	P.V of Residual payment=($50000*.705)	$           35,250
	Total	$       6,76,273
	Present Value of $1 at 6% for 7 years	0.705
	Present Value of annuity at 6% for 7 years	5.582
d)	Journal Entries
Date	Particular	Amt (Dr)	Amt (Cr)
01-01-2017	Lease Equipment	$       6,76,273
	To Lease Liability		$       6,76,273
	(Being amount of lease payment)
01-01-2017	Lease liability	$       1,14,838
	To Cash		$       1,14,838
	(Being amount of lease
31-12-2017	Depreciation Expense
	To Accumulated Depreciation($676273-$5000)/7	$           89,468
			$           89,468
31-12-2017	Interest Expense	$           61,758
	To Interest Payable($676273-$114837))*6%		$           61,758
01-01-2018	Lease liability	$           53,080
	Interest Payable	$           61,758
	To Cash		$       1,14,838
	(Being amount of lease liability)
31-12-2018	Depreciation Expense	$           89,468
	To Accumulated Depreciation		$           89,468
	(Being amount of Depreciation)
31-12-2018	Interest Expense	$           30,501
	To Interest Payable($676273-$114837-$53079.62))*6%		$           30,501
	In the books of Glause
Date	Particular	Amt (Dr)	Amt (Cr)
01-01-2017	Lease Receivable	$       7,00,000
	Cost of goods sold	$       5,25,000
	To Sales Revenue		$       7,00,000
	To Inventory		$       5,25,000
	(Being amount of sale of Machinery)
01-01-2017	Cash	$       1,14,838
	To Lease Receivable		$       1,14,838
	(Being amount received for lease payment)
31-12-2017	Interest Receivable	$           29,258
	To Interest Revenue($700000-$114837)*5%		$           29,258
01-01-2018	Cash	$       1,14,838
	To Lease Receivable		$           85,579
	To Interest Receivable		$           29,258
	(Being amount of Cash received for lease payment and interest)
31-12-2018	Interest Receivable	$           24,979
	To Interest Revenue($700000-$114837-$85579)*5%		$           24,979
	(Being amount of Interest Receivable)