Question

On January 1, 2018, Allied Industries leased a high-performance conveyer to Karrier Company for a four-year period ending December 31, 2021, at which time possession of the leased asset will revert back to Allied. The equipment cost Allied $956,000 and has an expected useful life of five years. Allied expects the residual value at December 31, 2022, will be $300,000. Negotiations led to the lessee guaranteeing a $340,000 residual value.

Equal payments under the finance/sales-type lease are $200,000 and are due on December 31 of each year with the first payment being made on December 31, 2018. Karrier is aware that Allied used a 5% interest rate when calculating lease payments.

Required:

1. Prepare the appropriate entries for both Karrier and Allied on January 1, 2018, to record the lease.

2. Prepare all appropriate entries for both Karrier and Allied on December 31, 2018, related to the lease.

Answer 1

In the books of Karrier
Journal entries
Date	Particulars	Debit ($)	Credit ($)
01-01-18	Conveyor on Lease	975589
	Allied Industries		975589
	(Being the high performance conveyor taken on lease)
31-12-18	Finance charge (975589 x 5%)	48779.45
	Allied Industries		48779.45
	(Being finance charges recorded on lease)
31-12-18	Profit and loss account	48779.45
	Finance charge (975589 x 5%)		48779.45
	(Being finance charges adjusted against the profit and loss account)
31-12-18	Allied Industries	200000
	Bank		200000
	(Being the annul lease payment made)

In the books of Allied
Journal entries
Date	Particulars	Debit ($)	Credit ($)
01-01-18	Karrier Company	975589
	Conveyor on lease		975589
	(Being the conveyor given on lease)
31-12-18	Karrier Company (975589 x 5%)	48779.45
	Interest on lease		48779.45
	(Being the interest on outstanding lease amount recorded)
31-12-18	Interest on lease	48779.45
	Profit and loss account		48779.45
	(Being interest is credited to the profit and loss account)
31-12-18	Bank	200000
	Karrier Company		200000
	(Being the annul lease payment received)

Workings:

Present value of lease for lessor and the lessee
Year	(A): Annual lease / Guaranteed residual value	(B): PV factors @5% p.a.	Present value of lease (A x B)
1	200000	0.952381	190476.2
2	200000	0.907029	181405.9
3	200000	0.863838	172767.5
4	200000	0.822702	164540.5
5	340000	0.783526	266398.9
Present value of lease			975589