Question

Metlock Corporation enters into a 6-year lease of equipment on December 31, 2016, which requires 6 annual payments of $37,100 each, beginning December 31, 2016. In addition, Metlock guarantees the lessor a residual value of $20,900 at the end of the lease. However, Metlock believes it is probable that the expected residual value at the end of the lease term will be $10,900. The equipment has a useful life of 6 years. Assume that for Lost Ark Company, the lessor, collectibility of lease payments is probable and the carrying amount of the equipment is $130,000. Prepare Lost Ark’s 2016 and 2017 journal entries, assuming the implicit rate of the lease is 10% and this is known to Metlock.

Answer 1

A leàse is classified as financing lease if any of the following conditions are satisfied :-

1 . Assets is to be transferred to lessee at the end of lease term.

2 . Lessee has the option to purchase the assets at below fair value

3 . Lease term is for significant part of asset's useful life

4. Present value of future lease payment is substantially amounts to assets fair value

5 . Leased asset is specialized in nature.

In the given case we can see that lease term is 6 years and equipment also has a useful life of 6 years thus 1 of the 5 conditions are satisfied, thus, lease would be classified as Finance lease.

Now present value of lease receivable will be pv of (minimum lease payment + guaranteed residual value + unguaranteed residual value)

Accordingly, 37100x3.79+20900x0.62

= 153615

Journal entries for 2016 & 2017 are as follows :-

Date	accounts title	debit	Credit
Dec 31, 2016	lease receivable To equipment (Lease entered)	153615	153615
Dec 31, 2016	cash To lease receivable (To lease payment recorded)	37100	37100
Dec 31, 2017	cash To Finance income (37100x10%) To lease receivable (37100-3710) (To lease payment recorded)	37100	3710 33390