Question

Eastern Edison Company leased equipment from Low-Tech Company on January 1, 2021. Low-Tech manufactured the equipment at a cost of $120,000. Annual payments are $12,590 with the first payment on January 1, 2021.

Other information:

Lease term	3 years
Useful life of asset	10 years
Fair value of equipment	$120,000
Interest rate	5%
Present value of an ordinary annuity of $1 (n = 3, i=5%)	2.72325
Present value of an annuity due of $1 (n=3, i=5%)	2.85941

Required: Prepare appropriate journal entries for Low-Tech (the lessor) for 2021. Assume straight-line amortization and a December 31 year-end.

[1] What is the appropriate classification for this lease (finance/sales-type or operating)? Why?

[2] Prepare the journal entry or entries, for the lessor, necessary at the time of lease signing (January 1, 2021). If no entry is necessary, write "no entry needed".

[3] Prepare the journal entry or entries, for the lessor, necessary at the time of the first lease payment (January 1, 2021).

[4] Prepare the journal entry or entries, for the lessor, necessary at the second lease payment (December 31, 2021).

Answer 1

1)
Its operating lease because it does not satisfy the following condition for treating finance lease.
Is the lease term equal to 75% or more of the expected  economic life of the asset (3 yrs < 75% x 10 yrs = 7.5 yrs)	No
Is the present value of the minimum lease payments equal to or greater than 90% of the fair value of the asset.($35,999.97 < 90% x 120,000 = 108,000)	No
Date	Particulars	Debit	Credit
	2) Record the lease.
Jan.1 2016	Lease receivable ($12,590 x 3)	$37,770
	Unearned interest revenue (Difference)		$1,770.03
	Equipment inventory (12,590 x 2.85941)		$35,999.97
	3) Record the cash receipt for the annual payments.
	Cash	$12,590
	Lease Receivables		$12,590
	4) Record the entry for the interest revenue.
Dec. 31 2016	Unearned interest revenue	$1,170.5
	Interest Revenue		$1,170.5
	[($35,999.97 - $12,590) x 5%]