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 ______.

Present value of $1			Present value of an ordinary annuity of $1
Years	10%	12%	Years	10%	12%
1	.90909	.89286	1	.90909	.89286
2	.82645	.79719	2	1.73554	1.69005
3	.75131	.71178	3	2.48685	2.40183
4	.68301	.63552	4	3.16986	3.03735
5	.62092	.56743	5	3.79079	3.60478

Answer 1

Answer-1:

The present value of the minimum lease payment (PVMLP) is $365,760

Answer-2:

Date	General Journal	Debit	Credit
12/31/2017	Right of use asset	$ 365,760
	Lease liability		$ 365,760
12/31/2017	Lease liability	130,960
	Cash		130,960
12/31/2018	Lease liability	107,480
	Interest expense	23,480
	Cash		130,960
12/31/2018	Depreciation expense	60,960
	Accumulated depreciation-Capital lease		60,960

Explanation:

Lease Amortization Schedule
Date	Annual payment	Interest on liability	Reduction of lease Liability	Lease liability
31/12/2017				$           365,760
31/12/2017	$       130,960		$              130,960	234,800
31/12/2018	$       130,960	$        23,480	107,480	127,320
31/12/2019	$       130,960	$        12,732	118,228	9,092
31/12/2020	10,000	$              908	9,092	-

Answer-3:

Date	General Journal	Debit	Credit
12/31/2017	Lease receivable	$ 365,760
	Cost of goods sold	300,000
	Sales revenue		$ 365,760
	Inventory		300,000
12/31/2017	Cash	130,960
	Lease receivable		130,960
12/31/2018	Cash	130,960
	Lease receivable		23,480
	Interest revenue		107,480

Answer-4:

12/31/2020	Lease liability	9,092
	Interest expense	908
	Cash		10,000
12/31/2020	Depreciation expense	60,960
	Accumulated depreciation-Capital lease		60,960