Question

General, Inc. leases equipment to different types of businesses. The company generally acquires the equipment and leases the equipment to its customers under long-term sales-type leases. General’s implicit interest in the lease arrangements is 10% annual rate.

General leased its machine that it purchased for $30,900 to a lessee, Oscar Company on January 1, 2018. The lease contract specified annual payments of $8,000 beginning January 1, 2018, the beginning of the lease, and each January 1 through 2020 (three-year lease term). Oscar Company has the option to purchase the machine at the end of the lease term, December 31, 2020, for $12,000 when it is expected to have a residual value of $16,000, considered a bargain purchase amount. The Company’s year-end is 12/31.

Required:

1. Show how General calculated the $8,000 annual lease payments for this sales-type lease.

2. Prepare an amortization schedule that describes the pattern of interest revenue for General, Inc. over the lease term.

3. Prepare the appropriate entries for General, Inc. from the beginning of the lease through the end of the lease term.

Answer 1

Solution

General Inc

Computation to show the calculation of annual lease payments for the sales-type lease:

Since the lease is a direct financing lease,

Total Annual lease payments = fair market value - present value of bargain purchase price at the implicit rate

Fair market value

Fair value of asset leased = $30,900

PV of bargain purchase price calculation,

Bargain purchase price= $12,000

Factor at 3 years, at 10% is = 12,000 x (P/F, 10%, 3) = 12,000 x 0.7513 = $9,016

Amount recovered through payments over 3-year lease term = $30,900 - $9,016 = $21,884

Present value of an annuity due at $1, for 3 years at 10% is = 2.73554

Hence, annual lease payments = $21,884/2.73554 = $8,000

1. Amortization schedule that describes the pattern of interest revenue for General Inc over the lease term:

Amortization Schedule
Date		Payment		Interest at 10%		Decrease in Balance		Outstanding Balance
1/1/2018								$30,900
1/1/2018		$8,000				$8,000		$22,900
12/31/2018		$8,000		$2,290		$5,710		$17,190
12/31/2019		$8,000		$1,719		$6,281		$10,909
12/31/2020		$12,000		$1,091		$10,909		$0
Total	$36,000		$5,100		$30,900

1. Journal Entries for General Inc

Date	Account Titles and Explanation		Debit	Credit
1/1/2018	Lease Receivable		$30,900
	Machinery			$30,900
	(To record start of lease)
1/1/2018	Cash		$8,000
	Lease Receivable			$8,000
	(To record receipt of annual rental revenue)
12/31/2018	Cash		$8,000
	Interest Revenue			$2,290
	Lease Receivable			$5,710
	(To record interest revenue received and lease receivable)
12/31/2019	Cash		$8,000
	Interest Revenue			$1,719
	Lease Receivable			$6,281
	(To record interest revenue received and lease receivable)
12/31/2020	Cash		$12,000
	Interest Revenue			$1,091
	Lease Receivable			$10,909
	(To record interest revenue received and lease receivable)