Question

Mariner Corporation, which manufactures sail boats, ordered dry dock equipment from Brown Corporation. This equipment was built for the specialized needs of Mariner, and could not be used by any other company. Instead of purchasing the equipment, Mariner elected to enter into a long term lease agreement with Brown Co. The lease contract was signed on January 1, 2020.   It calls for 12 payments of $15,000, with the first one due on December 31, 2020. The lessor’s implicit interest rate is not known. Mariner’s incremental borrow rate is 8%.

a. Is this lease a finance or operating lease? Explain.

b. Present the journal entry to be made by Mariner when the lease is signed.

c. Show the journal entry that Mariner will make for the December 31, 2020 payment.

Answer 1

a.) Condition which are considered to be financial lease..

(i) If lessee become the owner at the end of the lease term

(ii) If lessee can become with pay a nominal amount at the end of the lease term.

(iii) If lease term is approximately equal to the life of asset.

(iv) If asset is of any specialized nature which cannot be used by others.

(v) If present value of all installments is approximately equal to the value of the assets.

If any on of the above conditions is fulfilled it is FINANCIAL LEASE.

The asset is of Specialized nature. Therefore it will be considered as financial lease.

b.) Calculation of fair market value of the assets

Annuity factor of 12 years of 8% is 7.5361

Present value of lease payments/Fair Value = $15000*7.5361 = $113041

Journal Entries

Date	Particulars	Debit ($)	Credit ($)
Jan,1 2020	Equipment lease liability (Being asset recorded )	113041	- 113041

c.) Calculation of interest paid in first year = F.V.* Interest rate

= 113041*8% = $9043

Journal Entries

Date	Particulars	Debit ($)	Credit ($)
Dec,31 2020	Financial charges Equipment Cash (Being installment paid )	9043 5957	- - 15000
Dec,31 2020	Profit & Loss Financial charges (Being financial charges written off)	9043 -	- 9043