Question

Monty Leasing Company agrees to lease machinery to Flounder 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 $489,000, and the fair value of the asset on January 1, 2017, is $699,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $94,000. Flounder depreciates all of its 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 reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Monty desires a 9% rate of return on its investments. Flounder’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.) Click here to view factor tables Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Annual rental payment $ SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Present value of minimum lease payments $ SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Prepare the journal entries Flounder would make in 2017 and 2018 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.) Date Account Titles and Explanation Debit Credit (To record the lease.) (To record lease payment.) (To record depreciation.) (To record interest.) 1/1/18 (To record depreciation.) (To record interest.) SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Prepare the journal entries Monty would make in 2017 and 2018. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.) Date Account Titles and Explanation Debit Credit 1/1/17 (To record the lease.) (To record lease payment.)

Answer 1

Part A

amount of the annual rental payment = (699000 - (94000*0.54703)) / 5.03295 = 128,668

Present value of $1 at 9% for 7 periods = 0.54703

Present value of an annuity due at 9% for 7 periods = 5.03295

Part B

Present value of minimum lease payments = 737288

PV of annual payments: $128,668 * 5.35526 = 689051

PV of guaranteed residual value: $94000 * 0.51316= 48237

Present value of minimum lease payments = 737288

Present value of an annuity due at 10% for 7 periods = 5.35526

Present value of $1 at 10% for 7 periods = 0.51316

Part C

Date	account titles and explanation	debit	credit
1/1/17	leased equipment	737288
	Lease liability		737288
	(to record the lease)
	Lease liability	128668
	Cash		128668
	(to record lease payment)
12/31/17	depreciation expense	91898
	Accumulated depreciation - capital leases (737288-94000)/7		91898
	(to record depreciation)
	Interest expense	60862
	Interest payable (737288-128668)*0.10		60862
	(to record interest)
1/1/18	interest payable	60862
	Lease liability (128668-60862)	67806
	Cash		128668
12/31/18	depreciation expense	91898
	Accumulated depreciation - capital leases		91898
	(to record depreciation
	Interest expense	54081
	Interest payable (737288-128668-67806)*0.10		54081
	(to record interest)

Part D

Date	account titles and explanation	debit	credit
1/1/17	lease receivable	699000
	Cost of goods sold	489000
	Sales revenue		699000
	Inventory		489000
	(to record the lease)
	Cash	128668
	Lease receivable		128668
	(to record the lease payment)
12/31/17	interest receivable	51330
	Interest revenue (699000-128668)*0.09		51330
1/1/18	Cash	128668
	Lease receivable (128668-51330)		77338
	Interest receivable		51330
12/31/18	interest receivable	44369
	Interest revenue (699000-128668-77338)*0.09		44369