Question

Glaus Leasing Company agrees to lease equipment to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement. 1.The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2.The cost of the machinery is $525,000, and the fair value of the asset on January 1, 2017, is $700,000. 3.At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $50,000. Jensen estimates that the expected residual value at the end of the lease term will be $50,000. Jensen amortizes all of its leased equipment on a straight-line basis. 4.The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 5.The collectibility of the lease payments is probable. 6.Glaus desires a 5% rate of return on its investments. Jensen's incremental borrowing rate is 6%, and the lessor's implicit rate is unknown. Instructions (Assume the accounting period ends on December 31.) (a) Discuss the nature of this lease for both the lessee and the lessor. (b) Calculate the amount of the annual rental payment required. (c) Compute the value of the lease liability to the lessee. (d) Prepare the journal entries Jensen would make in 2017 and 2018 related to the lease arrangement. (e) Prepare the journal entries Glaus would make in 2017 and 2018 related to the lease arrangement. (f) Suppose Jensen expects the residual value at the end of the lease term to be $40,000 but still guarantees a residual of $50,000. Compute the value of the lease liability at lease commencement.

Answer 1

	P.V of $1 5% for 7 years	0.71068
	P.V of Annuity due 5% for 7 Years	6.07569
	P.V of annuity due table is used when payment is made at the beginning of the year
	P.V of$1 6% for 7 Years	0.66506
	P.V of annuity due of $1 6% for 7 years	5.91732
	Glaus Leasing Company
a)	This lease is a capital lease to Jenson because lease term is greater than 75% of economics life of the leased assets.
	Lease Term	7	Years
	Economic life	9	Years
	Lease Term=(7/9)*100	78%
	This lease is a capital lease to Glause lease because
1)	Collectibility of lease payment is reasonably predictable.
2)	Lease term is > 75% of economic life
b)	Annual Rental=($700000-$50000*.71068)/6.07569	$       1,09,365
c)	Present Value of minimum lease payment
	P.V of annual payment=($109365*5.91732)	$       6,47,146
	P.V of Residual payment=($50000*.66506)	$           33,253
	Total	$       6,80,399
d)	Journal Entries in the books of Jenson
Date	Particular	Amt (Dr)	Amt (Cr)
01-01-2017	Lease Equipment	$       6,80,399
	Lease Liability		$       6,80,399
	( Amount of lease payment)
01-01-2017	Lease liability	$       1,09,365
	Cash		$       1,09,365
	( Amount of lease liability paid)
31-12-2017	Depreciation Expense
	Accumulated Depreciation($680399-50000)/7	$           90,057
	(Amount of Depreciation Expense)		$           90,057
31-12-2017	Interest Expense	$           34,262
	Interest Payable($680399-$109365))*6%		$           34,262
	(Amount of Interest Expense)
01-01-2018	Lease liability($109365-$34262)	$           75,103
	Interest Payable	$           34,262
	Cash		$       1,09,365
	(Amount of lease liability)
31-12-2018	Depreciation Expense($680399-50000)/7	$           90,057
	Accumulated Depreciation		$           90,057
	(Amount of Depreciation)
31-12-2018	Interest Expense($680399-$109365-$75103)*6%	$           29,756
	Interest Payable		$           29,756
e)
In the books of Glause Leasing
Date	Particular	Amt (Dr)	Amt (Cr)
01-01-2017	Lease Receivable	$       7,00,000
	Cost of goods sold	$       5,25,000
	Sales Revenue		$       7,00,000
	Inventory		$       5,25,000
	( Amount of sale of Machinery)
01-01-2017	Cash	$       1,09,365
	Lease Receivable		$       1,09,365
	( Amount received for lease payment)
31-12-2017	Interest Receivable	$           29,532
	Interest Revenue($700000-$109365)5%		$           29,532
	(Amount of Interest Revenue)
01-01-2018	Cash	$       1,09,365
	Lease Receivable($109365-$29532)		$           79,833
	Interest Receivable		$           29,532
	( Amount of Cash received for lease payment and interest)
31-12-2018	Interest Receivable	$           25,540
	Interest Revenue($700000-$109365-$79833)*5%		$           25,540
	( Amount of Interest Receivable)