Question

On December 31, 2018, Yard Art Landscaping leased a delivery truck from Branch Motors. Branch paid $36,000 for the truck. Its retail value is $49,355.

The lease agreement specified annual payments of $12,000 beginning December 31, 2018, the beginning of the lease, and at each December 31 through 2021. Branch Motors’ interest rate for determining payments was 10%. At the end of the four-year lease term (December 31, 2022) the truck was expected to be worth $11,000. The estimated useful life of the truck is five years with no salvage value. Both companies use straight-line amortization or depreciation.

Yard Art guaranteed a residual value of $7,000. Yard Art’s incremental borrowing rate is 7% and is unaware of Branch’s implicit rate.

Required:

1) How should this lease be classified by Yard Art Landscaping (the lessee)?
2) Calculate the amount Yard Art Landscaping would record as a right-of-use asset and a lease liability.
3) How should this lease be classified by Branch Motors (the lessor)?
4) Show how Branch Motors calculated the $12,000 annual lease payments.
5) Calculate the amount Branch Motors would record as sales revenue.
6) Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2018.
7) Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Yard Art.
8) Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Branch Motors.
9) Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2019.
10) Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2022 (the end of the lease term), assuming the truck is returned to the lessor and the actual residual value of the truck was $5,000 on that date

Answer 1

Solution:-

(1) This lease should be classified as Financial lease

(2) The amount Yard Art Landscaping would record :-

   Right of use ( Leased asset) =

                   The time value factor for an ordinary annuity at 7% for 3 periods is 2.624

           The asset and liability will be recorded by multiplying the annual lease payment by the present value factor

                           12000 + 12000*2.624= 43488

(3) This lease should be classified as Financial lease

(4) Calculation of annual lease payment :-

              PV of Outflow = PV of Inflow

            Let x is the annual lease payment

              The time value factor for an ordinary annuity at 10% for 3 periods is 2.487

             49355 = (x + x*2.487) + 11000*0.683

            49355 = 3.487x + 7513

                   x = 12000