Question

On January 1, 2017, Carla Vista Company leased equipment to Flynn Corporation. The following information pertains to this lease: 1. The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equipment for $2,000, while the expected residual value at the end of the lease is $5,000. 2. Equal rental payments are due on January 1 of each year, beginning in 2017. 3. The fair value of the equipment on January 1, 2017, is $160,000, and its cost is $130,000. 4. The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis. 5. Carla Vista set the annual rental to ensure a 5% rate of return. Flynn’s incremental borrowing rate is 6%, and the implicit rate of the lessor is unknown. 6. Collectibility of lease payments by the lessor is probable. Both the lessor and the lessee’s accounting periods end on December 31. Click here to view the factor table. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Discuss the nature of this lease to Carla Vista and Flynn. The nature of this lease for Carla Vista is a lease. The nature of this lease for Flynn is a lease. SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Calculate the amount of the annual rental payment. (Round answer to 0 decimal places, e.g. 5,275.) Annual rental payment $ SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Prepare all the necessary journal entries for Carla Vista for 2017. (Credit account titles are automatically indented when the amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,275.) Date Account Titles and Explanation Debit Credit 1/1/17 (To record the lease) (To record lease payment) 12/31/17 SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Suppose the collectibility of the lease payments was not probable for Carla Vista. Prepare the necessary journal entry for the company in 2017. (Credit account titles are automatically indented when the amount is entered. Do not indent manually.) Date Account Titles and Explanation Debit Credit 1/1/17 SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Prepare all the necessary journal entries for Flynn for 2017. (Credit account titles are automatically indented when the amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,275.) Date Account Titles and Explanation Debit Credit 1/1/17 (To record the lease) (To record the receipt of lease payment) 12/31/17 (To record amortization of the right-of-use asset) (To record interest expense) SHOW LIST OF ACCOUNTS LINK TO TEXT LINK TO TEXT Prepare the effect on the journal entry for Flynn at lease commencement, assuming initial direct costs of $2,000 are incurred by Flynn for legal fees to execute the lease. (Credit account titles are automatically indented when the amount is entered. Do not indent manually.) Account Titles and Explanation Debit Credit

Answer 1

Part A

The nature of this lease for Flynn is a capital lease.

This is a capital lease to Flynn since the lease term is 75% (6 ÷ 8) of the asset’s economic life. In addition, the present value of the minimum lease payments is more than 90%of the fair value of the asset.

The nature of this lease for Carla Vista is a sales-type lease

This is a capital lease to Carla Vista since collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is 75% of the asset’s economic life. Because the fair value of the equipment ($160,000) exceeds the lessor’s cost ($130,000), the lease is a sales-type lease.

Part B

Amount of the annual rental payment = (160000-(((2000+5000)*0.74622))/5.32948 = 29042

Present value of $1 at 5% for 6 periods = 0.74622

Present value of an annuity due at 5% for 6 periods = 5.32948

Part C

Journal entries for Carla Vista for 2017

Date	Journal entries	debit	Credit
1/1/17	Lease Receivable	160000
	Cost of goods sold (130000-(((2000+5000)*0.74622))	124776
	Sales revenue		154776
	Inventory		130000
	(To record the lease)
	Cash	29042
	Lease receivable
	(To record lease payment)		29042
12/31/17	Interest receivable (160000-29042)*5%	6548
	Interest revenue		6548

Part D journal entries for Flynn for 2017.

Date	Journal entries	debit	Credit
1/1/17	Lease equipment (29402*5.21236)	153254
	Lease liability		153254
	(To record the lease)
	Lease liability	29402
	Cash		29402
	(To record the receipt of lease payment)
	Depreciation expense	25542
12/31/17	Accumulated depreciation - capital leases (153254/6)		25542
	(To record amortization of the right-of-use asset)
	Interest expense	7431
	Interest payable (153254-29402)*6%		7431
	(To record interest expense)