Question

Terms of a lease agreement and related facts were as follows:

1. The lease asset had a retail cash selling price of $124,000. Its useful life was six years with no residual value (straight-line depreciation).
2. Annual lease payments at the beginning of each year were $25,883, beginning January 1.
3. Lessor’s implicit rate when calculating annual rental payments was 10%.
4. Costs of $2,561 for legal fees for the lease execution were the responsibility of the lessor.

Required:
Prepare the appropriate entries for the lessor to record the lease, the initial payment at its beginning, and at the December 31 fiscal year-end under each of the following three independent assumptions:

1. The lease term is three years and the lessor paid $124,000 to acquire the asset (operating lease).
2. The lease term is six years and the lessor paid $124,000 to acquire the asset (sales-type lease). Also assume that adjusting the lease receivable (net investment) by initial direct costs reduces the effective rate of interest to 9%.
3. The lease term is six years and the lessor paid $97,000 to acquire the asset (sales-type lease).

Required 1

1. 01/01: Record the gross lease revenue received by lessor.

2. 01/01: Record the negotiating costs incurred by lessor.

3. 12/31: Record the lease revenue for lessor.

4. 12/31: Record the cost of the lease to the lessor.

5. 12/31: Record the depreciation for lessor.

Required 2

1. 01/01: Record the beginning of the lease for lessor.

2. 01/01: Record the negotiating costs incurred by lessor.

3. 01/01: Record the gross lease revenue received by lessor.

4. 12/31: Record the interest revenue for lessor.

Required 3

1. 01/01: Record the beginning of the lease for lessor.

2. 01/01: Record the negotiating costs incurred by lessor.

3. 01/01: Record the gross lease revenue received by lessor.

4. 12/31: Record the interest revenue for lessor.

Answer 1

Answer:

Requirement 1

January 1

Cash............................................................................................... 25883
     Unearned rent revenue*............................................................                25883

Deferred initial direct cost.........................................................   2561
Cash.............................................................................................   2561

December 31

Unearned rent revenue...........................................................  25883
Rent revenue*............................................................................ 25883

Lease expense ($2561 ÷ 3 years)...........................................     853.67
Deferred initial direct cost........................................................     853.67

Depreciation expense ($124000 ÷ 6 years)...........................  20666.67
Accumulated depreciation.........................................................   20666.67

*    Alternatively, Rent revenue.  Either way, an adjusting entry is needed at the end of the reporting period to assure that the earned portion of the payment is recorded in Rent revenue and the unearned portion in Unearned rent revenue

Requirement 2

January 1

          Proof that new effective rate is 9% (not required):

                     $126561 (124000+2561) ÷       4.88965**         =                  $25883.45

                       lessor's                                                                  lease
                 net investment                                                          payments

                                 ** Present value of an annuity due of $1: n=6, i=9%

January 1

Lease receivable (fair value / present value).................................. 124000

      Inventory of equipment (lessor's cost)..........................................              124000

Lease receivable.................................................................................    2561
     Cash (initial direct costs)...................................................................                  2561

Lease receivable.................................................................................    2561
     Cash (initial direct costs)..................................................................                  2561

Cash (lease payment)......................................................................... 25883
     Lease receivable................................................................................                25883

December 31

Interest receivable............................................................................    9061.02
     Interest revenue (9% x [$124000 + 2561 - 25883])....................                  9061.02

Requirement 3

January 1

Lease receivable (fair value / present value)...............................  124000

Cost of goods sold (lessor's cost).................................................... 97000
     Sales revenue (fair value / present value)...................................                 124000

Inventory of equipment (lessor's cost)............................................                   97000

Selling expense................................................................................    2561
     Cash (initial direct costs)..............................................................                     2561

Cash (lease payment)...................................................................... 25883
     Lease receivable...........................................................................                   25883

December 31

Interest receivable.........................................................................   9811.70
Interest revenue (10% x [$124000 - 25883])............................     9811.70