Question

OPTION #2 Lease: Non-cancelable lease agreement between Fifth-Third Leasing Company and Bob Evans Farms, a lessee

This question has been posted before with different values. However, there are several different solutions posted.

Please provide the following:

1. Prepare LEASE AMORTIZATION SCHEDULE suitable fo LESSEE for the lease term

2. Prepare JOURNAL ENTRIES for LESSEE for 2018 and 2019 - record lease agreement and all expenses relates to lease. Assume LESSEE'S annual accounting period ends on Dec 31 and reversing entries are used when appropriate.

3. Prepare JOURNAL ENTRIES for LESSOR of the transaction.

4. Analyze the specific outcomes and WRITE AN ANALYSIS directed toward the team at Fifth-Third Leasing Company describing what the numbers mean and how they relate to the business.  

Question:

1. What type of lease is this? Operating or Finance/Sales-Type? Why?

My thoughts:

--It seems to meet 2 of the 4 Finance lease criteria (lessee) - 1) term is equal to 75% or more of est. the economic life of the asset (6 yrs/8 yrs) and 2) the present value of minimum lease payments is equal to 90% or more of the fair value of the leased property to the lessor ($743,552/$800,000)

--it also seems to meet both additional Finance lease required criteria (lessor) - 1) collectibility of lease payments is predictable and 2) no important uncertainties surround unreimbursable costs yet to be incurred by the lessor under the lease

FACTS:

Inception date: January 1, 2018

Residual value of equipment at end of lease term, guaranteed by the lessee: $100,000

Lease term: 6 years

Economic life of leased equipment: 8 years

Fair value of asset at January 1, 2017: $800,000

Lessor's implicit rate: 10%

Lessee's incremental borrowing rate: 12%

The lessee assumes responsibility for all executory costs, which are expected to amount to $4,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $100,000. The lessee uses the straight-line depreciation method for all equipment.

Answer 1

10% 6.00 years Desired Rate of return for Lessor Lease term Calculate the amount of the annual rental Salvage Value Amount to be recovered (fair value) Less: Present Value of the residual value (100000 x 0.56447) Amount to be recovered through periodic lease payments payment. 100,000 800,000 (56,447) 743,553 Present Value of Annuity factor @10% n-6 years 4.79078 e payment at the beginning of each year 155,205 Year Year for discounting PV factor @10% 2 6 6 0.56447 0 0.909090.826450.75131 0.683010,.62092 1.00000 4.79078 Payments Required per year 155,205 Fair Value NPV Percentage Since present value of lease payments exceed 90% Lease term estimated useful life Percentage Since Lease term 275% of economic life of the leased property the same will be classified as Capital Lease 800,000 765,348 96%)To be classified as Capital Lease 6 75% Lessee Books Assumed Lessor implicit rate is unknown to Lessor Workin Year Year for discountin Annual Lease Installments paid at the beginning of the 6 6 155,205 155,205 155,205155,205 155,205155,205 100,000 ar PV factor @12% Assumed Lessor implicit rate is unknown to Lessor Present Value of Min lease Value at which to be recorded as asset by lessee is lower of FMV or NPV Depreciation (FV-Salae value)/6 years 1.00000 155,205 0.71178 0.63552 0.56743 88,068 0.89286 0.79719 0.50663 ents 138,576 123,728 110,472 98,636 50,663 765,348 765,348 110,891 110,891 110,891 110,891 110,891 110,891 665,348 Repayment Schedule Reduction Principal Outstandin Charges Payment Amountg Liability 765,348 155,205155,205 610,143 81,988 528,155 91,826 436,329 155,205 102,846 333,483 Finance Annual Quarter 0 73,217 63,379 52,359 40,018 26,196 10,713 265,882 155,205 155,205 155,205 115,187 155,205 129,009 89,287 1,031,230 765,348 218,296 89,287 100,000 0.00 Lessee Books General Journal Jan 1, 2018 a Capital Lease -in the books of Lessee Lease Equipment Lease payable Debit Credit 765,348 765,348 To record the lease Jan 1, 2018 b) Record the down p Lease payable Cash to record lease ent 155,205 155,205 ent c) To record the depreciation 31-Dec Depreciation Expense Accumulated depreciation 110,891 110,891 d) To record executory costs 31-Dec Executory Costs Cash 31-Dec e) Record the interest expense Interest Expense Interest Payable 4,000 4,000 73,217 73,217 Jan 1, 2019 Interest Payable Lease payable Cash 31-Dec Depreciation Expense Accumulated depreciation 73,217 81,988 155,205 110,891 110,891 31-Dec Executory Costs Cash 4,000 4,000 31-Dec Interest Expense Interest Pavable 63,379 63,379 Workin Year Year for discountin Annual Lease Installments paid at the beginning of the PV factor @10% Present Value of Min lease Lease Recoverable 6 6 Total 4 6 155,2051 155,205100,000 155,205 1.00000 155,205 800,000 155,205 0.90909 141,095 155,205 155,205 0.82645 128,269116,607 0.75131 0.68301 0.62092 0.56447 106,007 96,370 56,447 800,000 Repayment Schedule Reduction in Annual Payment Accounts Lease Receivable Recoverable 800,000 644,795 554,070 454,272 344,494 223,738 90,907 Year Interest Income 64,480 55,407 45,427 34,449 22,374 9,093 155,205155,205 90,725 99,798 155,205 109,778 120,756 155,205132,831 90,907 1,031,230 800,000 155,205 155,205 155,205 100,000 231,2301 Lessor Books General Journal a. To record lease Jan 1, 2018 Lease Recoverable Equipment Debit Credit $800,000 800,000 b) Record the down payment Jan 1, 2018 Cash Lease Receivable 155,205 155,205 31-Dec-18 c) Record the interest receivable Interest Receivable Interest Revenue 64,480 64,480 1 Jan 19 d) Receipt of second payment Cash Interest Revenue Lease Receivable 155,205 64,480 90,725 31-Dec-19 Interest Receivable Interest Revenue 55,407 55,407