Question

The One About Leases

Heartbreaker Leasing leases equipment to a variety of businesses. The company's primary service is acquiring equipment and leasing it to customers under long-term sales-type lease with a profit. Heartbreaker earns interest under these arrangements at a 10% annual rate.

The company recently purchased an electronic typesetting machine for $100,000 and leased it for total consideration of $123,600 to a local publisher, Petty Inc. on January 1, 2018. The lease contract specified annual payments of $32,000 beginning January 1, 2018, the beginning of the lease, and each January 1 through 2020 (three-year lease term). The publisher had the option to purchase the machine on December 30, 2020, the end of the lease term, for $48,000 when it was expected to have a residual value of $64,000, a sufficient difference that exercise seems reasonably certain. Petty believes the asset has a 6-year useful life and anticipates acquiring the asset at the end of the 3-year lease term (at the price of $48,000).

Required:

Round your answers to the nearest whole dollar amounts.

1. Show how Heartbreaker calculated the $32,000 annual lease payments for this sales-type lease.

2. Prepare the appropriate journal entries for Petty Inc. for the following dates:

a. January 1, 2018: Acquisition of the asset and first lease payment.

b. December 31, 2018: required adjusting entries.

c. January 1, 2019: Second lease payment.

Answer 1

Answer:-

1:- = Statement showing how heartbreaker charge $32000 as lease rent as follows:-

Note:- At the end of the year machine will be sold to lessee for $48000.

Now, we will calculate the present value of such machine value at the end of the year, here lessor will get $ 48000 when he will sell to lessee,

Therefore, Present Value of $ 48000 = $ 48000 * ( Present value factor @ 10% for 3 year)

= $ 48000 * 0.751

= $ 36048

Hence, total purchase consideration is $ 123600, so at the end of third year lessor will got $ 36048 hence remaing amount will get lessor from lease payment.

So, Remaining amount to recover = $ 123600 - $ 36048 = $ 87552

Therefore, Lease Payment = $ 87552 / Present Value of 10 % for 3 years beginning)

= $ 87552 / (1 + 0.909 + 0.826)

= $ 87552 / 2.735

= $ 32011 round off

= $ 32000

2.) Journal entries:-

January 1, 2018=

1.) Puchase of asset Account Dr. $ 100000

To Bank $ 100000

( Being assets purchased for cash)

2.) Cash A/c Dr. $ 32000

To Lease Receivable $ 32000

( Being amount received from lease payment)

Date = 01 January, 2019

1.) Cash Account Dr. $ 32000

To Lease Receivable $ 26445 (Note 1 )

To finance Income $ 5555 (Note 1 )

( Being lease payment received)

Note1:- January 1, 2018 = Principal amount = 87552 - 32000 = 55552

January 1, 2019 = Princiapl amount = $ 26445 ( 32000 - 5555), (55552 * 10% = 5555)

Finance income = 55552 8 10% = 5555