Question

3. Use the following information to answer the questions below.

• The equipment of lease has 5-year service life with no salvage value.
• The lease term is 5 years, requiring equal payment of $11,990.81 at the beginning of year.
• The annual $11,990.81 rental payment includes $1,000 insurance and property taxes per year.
• The lessee depreciates similar equipment on a straight-line basis.
• The discount rate is 10%.

1. Determine whether the lease is capital lease or operating lease, and why.

2. Using the appropriate factor, calculate the present value of lease payments.

FVF_{5, 10%} = 1.61051

PVF_{5, 10%} = .62092

FVF-OA_{5, 10%} = 6.10510

PVF-OA_{5, 10%} = 3.79079

PVF-AD_{5, 10%} = 4.16986

3. Complete the following lease amortization schedule.

Year. Lease Payment. Executory Costs. Interest (10%). Lease-liability reduction. carrying lease liability.  

1

2

3

4

5

4. Prepare the journal entries at the beginning of lease.

5. Prepare the journal entries at the end of Year 1 (=at the beginning of Year 2).

Answer 1

Solution-(a)	Lease is a Capital lease
	Reason :
	Since service life (economic life ) of the lease which is 5 years, is equal to the lease term which is 5 years, the lease is a capital lease.
Solution-(b)	Present value of lease payment
	= Annual lease payment * Annuity factor of 5 years at the rate of 10%
	Where,
	Annual lease payment = 11990.81-1000 = 10990.81
	5 Years annuity factor @ 10% =3.79079
	Hence,
	Present value of lease payment = 10990.81*3.79079
	= $ 41663.85

Solution-(c)	Lease amortization schedule
Year	Lease payment	Executory cost	interest @ 10%	Lease liability reduction	carrying lease liability
0	10990.81	41663.85	4166.39	6824.43	34839.43
1	10990.81	34839.43	3483.94	7506.87	27332.56
2	10990.81	27332.56	2733.26	8257.55	19075.00
3	10990.81	19075.00	1907.50	9083.31	9991.69
4	10990.81	9991.69	999.12	9991.69	0.00
5	0	0.00	0.00	0.00	0.00

Solution-(d)	Journal entry at the beginning of lease lessor's books of account
	Year-1	Debit	credit
1	Lease payment receivable	41663.85
	To equipment on lease		41663.85
	( assets transferred on lease for five years at the annual lease payment of $ 41663.85)
2	Cash/Bank	10990.81
	To Lease payment receivable		6824.43
	To Unrealized interest income on lease		4166.39
	( annual lease payment received and accounted in books of accounts)
3	Unrealized interest income on lease	4166.39
	To Income statement		4166.39
	( amount transferred income statement )
Solution-(e)	Journal entry at the beginning of lease lessor's books of account
	Year-2	Debit	credit
1	Lease payment receivable	34839.43
	To equipment on lease		34839.43
	( assets transferred on lease for five years at the annual lease payment of $ 41663.85)
2	Cash/Bank	10990.81
	To Lease payment receivable		7506.87
	To Unrealized interest income on lease		3483.94
	( annual lease payment received and accounted in books of accounts)
3	Unrealized interest income on lease	3483.94
	To Income statement		3483.94
	( amount transferred income statement )