Question

Recording Finance Lease Journal Entries— Guaranteed Residual Value

Smith, the lessee, signs an 8-year lease agreement of a floor of a building on December 31, 2020, that requires annual payments of $70,000, beginning immediately. The residual value is guaranteed to the lessor of $50,000 at the end of the lease term. Smith estimates that the residual will have a value of $30,000 at the end of the lease term. Smith is aware of the lessor’s implicit rate of interest of 7%. Record Smith’s journal entries on December 31, 2020, assuming that the lease is properly classified as a finance lease.

• Note: Round your answers to the nearest whole dollar.

Date	Account Name	Dr.	Cr.
Dec. 31, 2020	AnswerCashInitial Direct CostInventoryPrepaid Maintenance ExpenseEquipmentAccumulated DepreciationLease ReceivableRight-of-Use AssetAccrued Legal ExpenseDeferred Lease RevenueDeposit LiabilityLease Incentive PayableLease LiabilitySales RevenueInterest RevenueLease RevenueCost of Goods SoldAmortization ExpenseDepreciation ExpenseInterest ExpenseLease ExpenseLoss on LeaseSelling Expense	Answer	Answer
	AnswerCashInitial Direct CostInventoryPrepaid Maintenance ExpenseEquipmentAccumulated DepreciationLease ReceivableRight-of-Use AssetAccrued Legal ExpenseDeferred Lease RevenueDeposit LiabilityLease Incentive PayableLease LiabilitySales RevenueInterest RevenueLease RevenueCost of Goods SoldAmortization ExpenseDepreciation ExpenseInterest ExpenseLease ExpenseLoss on LeaseSelling Expense	Answer	Answer
	To record asset and liability
Dec. 31, 2020	AnswerCashInitial Direct CostInventoryPrepaid Maintenance ExpenseEquipmentAccumulated DepreciationLease ReceivableRight-of-Use AssetAccrued Legal ExpenseDeferred Lease RevenueDeposit LiabilityLease Incentive PayableLease LiabilitySales RevenueInterest RevenueLease RevenueCost of Goods SoldAmortization ExpenseDepreciation ExpenseInterest ExpenseLease ExpenseLoss on LeaseSelling Expense	Answer	Answer
	AnswerCashInitial Direct CostInventoryPrepaid Maintenance ExpenseEquipmentAccumulated DepreciationLease ReceivableRight-of-Use AssetAccrued Legal ExpenseDeferred Lease RevenueDeposit LiabilityLease Incentive PayableLease LiabilitySales RevenueInterest RevenueLease RevenueCost of Goods SoldAmortization ExpenseDepreciation ExpenseInterest ExpenseLease ExpenseLoss on LeaseSelling Expense	Answer	Answer
	To record cash lease payment

Answer 1

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Ans :

A finance lease (also known as a capital lease or a sales lease) is a type of lease in which a finance company is typically the legal owner of the asset for the duration of the lease, while the lessee not only has operating control over the asset, but also some share of the economic risks and returns from the change in the valuation of the underlying asset.

Financial Leasing is an alternative way of financing whereby a licensed leasing company (the “Lessor’) purchases an asset on behalf of its customer (the “Lessee”) in return for a contractually agreed series of payments which usually include an element of interest. The lessor maintains ownership of the asset while the lessee enjoys the use of the asset for the duration of the lease agreement, usually accompanied by an option to buy the asset at the end of the contract. The lessee bears all costs and risks associated with the use of the leased asset.

Investment cost - ? , useful life - 8 years , GRV – 50000 , Annual lease rental = $ 70000 , return on its investment / implicit rate of interest = 7 %

Since the first lease rental is paid immediately it is solved by annuity due formula

The present value of Lease rentals + Pv of guaranteed residual value = cost of asset

Lease rentals * PVIFA ( 7% , 7) + GRV * PVIF (7%,7)

= 70000 + 70000 * 5.38928 + 50000 * 0.6227 = 447250 + 31137 = $ 478387

a)

  

	Lease Amortization Schedule
Date	Annual Lease Payment Plus GRV (a)	Interest on Liability (b)= 7% on d	Reduction of Lease Liability (c = a-b)	Lease Liability (d)
12/31/20				478387
12/31/20	74,000		74,000	4,04,387
12/31/21	74,000	28307.09	45,693	3,58,694
12/31/22	74,000	25108.59	48,891	3,09,803
12/31/23	74,000	21686.19	52,314	2,57,489
12/31/24	74,000	18024.22	55,976	2,01,513

Ans : c) Journal entries

S No .	Date	General Journal		Dr. $	Cr. $
1	12/31/20	Right to use / equipment / PPE Lease liability	Dr. Cr.	478387	478387
2	12/31/20	Lease liability Cash	Dr. Cr.	74,000	74,000
3	12/31/21	Finance Charges/ Interest exp cash	Dr. Cr.	28307	28307
4	12/31/21	Amortization Expenses or Accumulated Depreciation Right to use [ Dep = ( Present Value – residual value ) / Life = 478387 – 50000 ) / 8	Dr. Cr.	53548	53548
5	12/31/21	Lease liability Cash	Dr. Cr.	45,693	45,693