Question

Rand Medical manufactures lithotripters. Lithotripsy uses shock waves instead of surgery to eliminate kidney stones. Physicians’ Leasing purchased a lithotripter from Rand for $2,710,000 and leased it to Mid-South Urologists Group, Inc., on January 1, 2018. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Lease Description: Quarterly lease payments $ 191,737—beginning of each period Lease term 5 years (20 quarters) No residual value; no purchase option Economic life of lithotripter 5 years Implicit interest rate and lessee's incremental borrowing rate 16% Fair value of asset $ 2,710,000

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 beginning of the lease through the second rental payment on April 1, 2018. Adjusting entries are 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 $2.3 million. Prepare appropriate entries for Rand Medical from the beginning of the lease through the second lease payment on April 1, 2018.

Answer 1

1. For classification of lease , we consider following points :-

• Is ownership transferred by the end of the lease term?
• Does the lease contain a bargain purchase option?
• Is the lease term for a major part of the asset's useful life?
• Is the present value of minimum lease payments subsequently equal to the assets's fair vaiue?

If the answer to all of the above questiobs is "NO" it is an operating lease, if answer any of the above question is "YES" It is a finance lease.

Since in this case Mid-South Urologists using the lithotripter for 5 years, and its uselife life also is 5 years. Thus they should classify this is finance lease.

2. Entries in the books of Mid-south Urologists group