Question

On January 1, 2020, Nivtop Corp. leased a machine from Nosnah Inc. The lease agreement calls for
Nivtop to make four annual lease payments of $559,113 each January 1, with the first payment to be
made on January 1, 2020. Nivtop’s incremental borrowing rate is 8%; this is the same rate Nosnah
used to calculate the lease payments. The fair market value of the machine is $2,000,000 and its
expected useful life is 5 years. This is a non-specialized machine.
Nosnah purchased the machine from a vendor on December 31, 2019 for $1,573,000.
Required
a. List the 5 criteria used to determine whether a lease qualifies as finance/sales-type or
operating. Review each criterion to determine which (if any) this lease meets.
b. What type of lease is this for Nivtop?
c. What type of lease is this for Nosnah?
d. Show all of Nivtop’s journal entries relative to this lease at
1) January 1, 2020
2) December 31, 2020
3) January 1, 2021
e. Show all of Nosnah’s journal entries relative to this lease at
1) January 1, 2020
2) December 31, 2020
3) January 1, 2021

Answer 1

Solution:

Step 1: Calculation of lease payments

Calculation of PV of Lease Payments
Lease Payment	559113
No of periods	4
Interest rate per period	8.00%
PV annuity due Factor @ 6% for 7years	3.57710
PV of Lease Paymenst (100000* PV factor)	2000000

It is a Finance Lease to Nivtop
Satisfying any one of th followingit satisfies two 4 criteria makes a lease a finance lease. Here its satisfies two
Transfer of Ownership	No information given
Bargain purchase option available4	No
Is the lease term equal to 75% or more than the estimated economic life of the property	Yes; It is 4/5 = 80% of economic life of the property
Is present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the property,	Yes, it is 100% . PV of lease payments = 2000000
Alternate use test - Is the underlying asset is of a specialised nature	No

It is a Sales type lease for Nosnah

The decising criteria is the same as the lessee for the lessor'

Step 2 : Journal Entries

Journal Entries - IN the Books of Lessee - Niv top
Date	Particulars	Debit	Credit
Jan 01, 2020	Right of use asset	2000000
	Lease Payable		2000000
Jan 01, 2020	Lease Payable	559113
	Cash		559113
Dec 31,2020	Interest Expense	115271
	Lease Liability		115271
Dec 31,2020	Amortization Expense	500000
	Right-to- Use Asset		500000
	(To record Amortization Expense (2000000/4)

Journal Entries - IN the Books of Lessor - Nosnah
Date	Particulars	Debit	Credit
Jan 01, 2020	Lease Receivable	2000000
	Cost of Goods Sold	1573000
	Sales Revenue		2000000
	Inventory		1573000
Jan 01, 2020	Cash	559113
	Lease Receivable		559113
Dec 31,2020	Lease Receivable	115271
	Interest Revenue		115271

Workings:

Lease Amortization Schedule
Date	Lease Payment (A)	Interest Expense (B) = (D) *Interest Rate	Reduction in Liability (C) = (A) - (B)	Lease Liability (D) = (D) - (C)
Jan 01, 2020				2000000
Jan 01, 2020	559113		559113	1440888
Jan 01, 2021	559113	115271	443842	997046
Jan 01, 2022	559113	79764	479349	517697
Jan 01, 2023	559113	41416	517697	0
Total	2236451	236450	2000000

Hope this helps! In case of any clarifications, kindly use the comment box below