Question

Direct financing and sales-type lease; lessee and lessor

Rand Medical manufactures lithotripters. Lithotripsy uses shock waves instead of surgery to eliminate kidney stones. Physicians’ Leasing purchased a lithotripter from Rand for $2,000,000 and leased it to Mid-South Urologists Group, Inc., on January 1, 2016.

Lease Description:
Quarterly lease payments	$130,516—beginning of each period
Lease term	5 years (20 quarters)
No residual value; no BPO
Economic life of lithotripter	5 years
Implicit interest rate and lessee’s incremental borrowing rate	12%
Fair value of asset	$2,000,000

Collectibility of the lease payments is reasonably assured, and there are no lessor costs yet to be incurred.

Required:

1.  How should this lease be classified by Mid-South Urologists Group and by Physicians’ Leasing?

2.  Prepare appropriate entries for both Mid-South Urologists Group and Physicians’ Leasing from the inception of the lease through the second rental payment on April 1, 2016. Depreciation is recorded at the end of each fiscal year (December 31).

3.  Assume Mid-South Urologists Group leased the lithotripter directly from the manufacturer, Rand Medical, which produced the machine at a cost of $1.7 million. Prepare appropriate entries for Rand Medical from the inception of the lease through the second lease payment on April 1, 2016.

Answer 1

Answer 1:-

PVMLP: Table 6, 20 payments @ 3%
15.32380 x $130,516 = $2,000,000
Lessee and Lessor Criteria : Atleast one of the criterion needs to be satisfied
1. Title transfer? No
2. Bargain purchase option? No
3 Lease term ≥ 75% of useful life? Yes it is 100% (5 ÷ 5)

4. PVMLP ≥ 90% FMV? Yes, it is 100% ($2,000,000 ÷ $2,000,000)

Additional Criteria for Lessor : Both need to be satisfied
1. Collectibllity of lease payments is reasonably assured? Yes
2. No lessor costs yet to be incurred? Yes
For lessee: Capital lease – meets 3rd and 4th criteria)
For lessor: Direct financing lease – meets 3rd and 4th criteria and additional
two criteria that are lessor specific, so it is a capital lease. Because the cost
and FMV (PVMLP) are equal, this is direct financing

Answer 2:

Date Payment Interest @3% Principal Balance
  1/1/2013 2,000,000
1/1/2013 130,516 130,516 1,869,484
4/1/2013 130,516 56,085 74,431 1,795,053

Physicians’ Leasing - Lessor

1/1/16 Lease receivable 2,000,000
Equipment 2,000,000

1/1/16 Cash 130,516
Lease receivable 130,516

4/1/16 Cash 130,516
Interest revenue 56,085
Lease receivable 74,431

Mid-South - Lessee

1/1/16 Leased Asset 2,000,000
Lease payable 2,000,000

1/1/16   Lease payable  130,516
Cash 130,516

4/1/16 Lease Payable 74,431
Interest revenue 56,085
Cash 130,516

12/31/2016  Depreciation expense 400,000
Accumulated depreciation 400,000
($2,000,000 ÷ 5 years)

Answwer 3:

This would be a sales-type lease for Rand Medical because the cost of $1.7
million is not equal to the FMV/PVMLP of $2,000,000.
1/1/16 Lease receivable 2,000,000
Sales 2,000,000
Cost of goods sold 1,700,000
Equipment inventory 1,700,000

1/1/16 Cash 130,516
Lease receivable 130,516

4/1/16 Cash 130,516
Interest revenue 56,085
Lease receivable 74,431