Question

Royal Ltd. manufactures equipment that is sold or leased. On 31 December 2017 Royal leased equipment to Water Ltd. for a non-cancelable lease term of three years ending 31 December 2020 at which time possession of leased asset will revert back to Royal Ltd.

The equipment cost $300,000 to manufacture and has an expected useful life of six years. Its normal sales price (fair value) is $365,760. The residual value was guaranteed by Water Ltd. for $10,000 at the end of lease term. Water Ltd. estimated the fair value of the equipment at end of lease term will be around $5,000.

Under the lease, three equal annual payments of $130,960 are due on December 31 of each year. The first payment was made on 31 December 2017. Water Ltd.’s incremental borrowing rate is 12%. Water knows the interest rate implicit in the lease payment is 10%. Both companies use straight-line depreciation and have the fiscal year ended at 31 December of each year. (Please use the discount table provided in your calculation, no decimal points in rounding, for example, 130.7 should be written as 131.)

Required:

1. The present value of the minimum lease payment (PVMLP) is _____.

2. Prepare the appropriate entries for Water Ltd. on 31 December 2017 & 2018. Indicate the date for each entry. Narratives for journal entries are not required.

3. Prepare the appropriate entries for Royal Ltd. on 31 December 2017. Narratives for journal entries are not required.

4. Prepare appropriate entries for Water Ltd. on 31 December 2020. Indicate the date for each entry. Narratives for journal entries are not required.

5. On the statement of financial position, as of 31 December 2018, the balance for current liabilities for Water Ltd. relating to the lease is ______, and noncurrent liabilities relating to the lease is ______.

Answer 1

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