Question

Exercise 21-12 (Part Level Submission)

On January 1, 2020, Pharoah Company leased equipment to Flynn Corporation. The following information pertains to this lease.

1.The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equipment for $1,000, while the expected residual value at the end of the lease is $9,000.

2.Equal rental payments are due on January 1 of each year, beginning in 2020.

3.The fair value of the equipment on January 1, 2020, is $120,000, and its cost is $110,000.

4.The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.

5.Pharoah set the annual rental to ensure a 6% rate of return. Flynn's incremental borrowing rate is 8%, and the implicit rate of the lessor is unknown.

6.Collectibility of lease payments by the lessor is probable.

Both the lessor and the lessee's accounting periods end on December 31.

a. What is the amount of the annual Rental Payment?

d.   Suppose the collectibility of the lease payments was not probable for Pharoah. What are the necessary journal entries for the company in 2020.

c.   What are the journal entries for Flynn for 2020.

Answer 1

AMOUNT OF ANNUAL RENTAL PAYMENT

DESCRIPTION		AMOUNT
	AMOUNT TO BE RECOVERED		$120,000
(Less)	Present value of residual(at 6% for 6 years) (9000*0.7047)	$6342.3	($6342.3)
	Present value of annual payments		$113657.7
	Present value for annuity due a 6   % for 6 years, payments beginning at the beginning of the year(1+4.9173)		$5.9173
	ANNUAL RENTAL PAYMENT (113657.7/5.9173)		$19207.7

THEREFORE THE ANNUAL PAYMENT IS $ 19207.

(d) necessary journal entries for the company in 2020 IF Collectibility of the lease payments was not probable,

DATE	Journal entry	Debit	Credit
1- jan	Lease receivable	$120,000
	Cost of goods sold (110,000-6342.3)	$103,658
	Sale		$113,658
	inventory		$110,000
	(To record the beginning of lease)
1- jan	Cash	$19,208
	Lease receivable		$19,208
	( To record lease payments receivable)
31- dec	Interest receivable {(120,000-19208)*6%}	$6,048
	Interest revenue		$6,048
	(To record interest revenue to be received)

(c)   journal entries for Flynn for 2020.

DATE	JOURNAL ENTRY	DEBIT	CREDIT
1-JAN	Leased equipment under capital lease (19208*(1+5.20637))	$119212
	lease liability		$119212
	(To record the lease of present value of annuity due for 8% for 6 years, lease beginning at the beginning of the period)
1-jan	Lease liability	$19208
	cash		$19208
	(to record the quarterly lease liability)
31-dec	interest expense (119212-19208)*8%	$8000
	Interest payable		$8000
	(to record the quarterly lease and interest payment)
	Depreciation expense (119212/6YEARS)	$19868
	Accumulated depreciation		$19868
	(to record the amortization expense)