Question

Universal Leasing leases electronic equipment to a variety of businesses. The company’s primary service is providing alternate financing by acquiring equipment and leasing it to customers under longterm leases. Universal earns interest under these arrangements at a 11% annual rate. Universal purchased an electronic typesetting machine on December 31, 2017, for $107,000 and then leased it to Desktop, Inc., a local publisher. The six-year operating lease term commenced January 1, 2018, and the lease contract specified annual payments of $9,700 beginning December 31, 2018 and each December 31 through 2023. The machine’s estimated useful life is 15 years with no estimated residual value. The publisher had the option to terminate the lease after four years. At the beginning of the lease, there was no reason to believe the lease would be terminated. Required: 1. Prepare the appropriate entries for Universal Leasing from the beginning of the lease through the end of 2018. 2. At the beginning of 2019, there was a significant indication that Desktop’s economic incentive to terminate the lease had changed causing both companies to believe termination of the lease at the end of four years (three years remaining) is “reasonably certain”. Prepare any appropriate entries for Universal Leasing at January 1, 2019, to reflect the change in the lease term. 3. Prepare the appropriate entries pertaining to the lease for Universal Leasing at December 31, 2019.

Answer 1

Req 1	Date	Account titles and explanation	Debit $	Credit $
	January 1, 2018	Lease receivable ($9,700 x 4.23054*)	$        41,036
		Residual asset ($107,000 – [$41,036 ÷ $107,000 x $107,000])	$        65,964
		Inventory of equipment (lessor’s cost)		$     107,000
		* Present value of an ordinary annuity of $1, n = 6, i = 11%
	December 31, 2018	Cash (lease payment)	$           9,700
		Lease receivable (difference)		$          5,186
		Interest revenue (11% x $41,036)		$          4,514
		Residual asset ($65,964 x 11%)	$           7,256
		Accretion revenue		$          7,256
Req 2	January 1, 2019	Residual asset	$        12,146
		Lease receivable (adjustment: calculation below) .		$        12,146
	The lease receivable and residual asset need to be revised to reflect the new lease term of four years, three years remaining after the first year. We calculate the balance needed in the lease receivable as the present value of the remaining three lease payments:
		Receivable balance after first year ($41,036 – 5,186)	35,850
		Balance needed after the change in lease term ($9,700 x 2.44371*)	23,704
		Adjustment needed	12,146
		* Present value of an ordinary annuity of $1, n = 3, i = 11%
Req 3	December 31, 2019	Cash (lease payment)	$           9,700
		Lease receivable (difference)		$          7,093
		Interest revenue (11% x $23,704)		$          2,607
		Residual asset ([$65,964 + 7,526 + 12,146] x 11%)	$           9,420
		Accretion revenue		$          9,420

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