Question

Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling Construction Corp. sign a lease agreement dated January 1, 2017, that calls for Caterpillar to lease a front-end loader to Sterling beginning January 1, 2017. The terms and provisions of the lease agreement, and other pertinent data, are as follows.

• The term of the lease is five years. The lease agreement is non-cancelable, requiring equal rental payments at the beginning of each year (annuity-due basis).

• The loader has a fair value at the inception of the lease of $50,000, an estimated economic life of five years, and no residual value of the loader at the end of the lease. Further, assume that the underlying asset has an $42,500 cost to the dealer, Caterpillar.

• The lease contains no renewal options. The loader reverts to Caterpillar at the termination of the lease.

• Collectability of payment by Caterpillar is probable.

• Caterpillar sets the annual rental payment to earn a rate of return of 4% per year (implicit rate) on its investment

Required:

1. What kind of lease is this to Caterpillar?

2. Calculate the amount of the annual rental payment required

3. Compute the amount of Lease Receivable for Caterpillar.

4. Prepare a journal entry to record the Lease Receivable on January 1, 2017

5. Prepare an amortization schedule that would be suitable for the lessor

6. Prepare journal entry to record Caterpillar receipt of the first year’s lease payment on January 1, 2017

7. Prepare journal entry to record accrued interest revenue on the lease receivable at Dec 31, 2017

8. Prepare a partial Balance Sheet for Caterpillar Finance as December 31, 2017

9. Prepare a partial Income Statement for Caterpillar Finance as December 31, 2017

10. Prepare journal entry to record the receipt of the lease payment of January 1, 2018

11. Prepare journal entry to record accrued interest revenue on the lease receivable at Dec 31, 2018

12. Prepare journal entry to record accrued interest revenue on the lease receivable at Dec 31, 2021

13. Prepare journal entry to record the return of leased asset to Caterpillar on January 1, 2022

Answer 1

Solutions:

1. The lease is classified as a Sale-type-Lease. The lease term is is more than 90% of the economic life of the Asset. Hence the lease is a finance lease to the lessor ( Caterpillar)

2.

Fair Value of the asset	$ 50000
Lease Payments at the beginning of each of the next six years (50000÷ 4.62990)	$ 10799

3.

Lease receivable is the present value of minimum lease payments - $50,000

Lease Receivable
PV of Lease Payments
Lease Payment	10799.38046
No of years	5
Interest rate	4%
PV annuity due Factor @ 4% for 5 years	4.62990
PV of Lease Payments	50000.00

4.

Journal Entries - In the Books of Lessor
	Lease Receivable	50000
01-Jan-2017	Cost of Goods Sold	42500
	Sales Revenue		50000
	Inventory		42500

5.

Lease Amortisation Schedule
Date	Lease Payment	Interest Revenue (Lease receivable *4%)	Reduction in Receivable	Lease Receivable
01-01-2017				50000
01-01-2017	10799.38		10799.38	39201
01-01-2018	10799.38	1568.02	9231.36	29969
01-01-2019	10799.38	1198.77	9600.61	20369
01-01-2020	10799.38	814.75	9984.63	10384
01-01-2021	10799.38	415.36	10384.02	0

6.

01-01-2017	Cash	10799
	Lease Receivable		10799
	(To record the first lease payment)

7.

31-12-2017	Lease Receivable	1568
	Interest Revenue		1568

8.

Current Assets
Lease Receivable	(1568+9321)	10799
Non Current Assets (Investments)
Lease Receivable		30753

9.

Income Statement
Sales Revenue	50000
Less: Cost of goods Sold	42500
Other Revenue
Interest Revenue	2352

10.

01-01-2018	Cash	10799
	Lease Receivable		10799
	(To record the first lease payment)

11.

31-12-2018	Lease Receivable	1199
	Interest Revenue		1199

12

31-12-2021	Lease Receivable	415
	Interest Revenue		415