Question

Laura Leasing Company signs an agreement on January 1, 2014, to lease equipment to Plote Company. The following information relates to this agreement.

1. The term of the noncancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years.
2. The fair value of the asset at January 1, 2014, is $91,900.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $7,300, none of which is guaranteed.
4. Plote Company assumes direct responsibility for all executory costs, which include the following annual amounts: (1) $865 to Rocky Mountain Insurance Company for insurance and (2) $1,517 to Laclede County for property taxes.
5. The agreement requires equal annual rental payments of $20,952.04 to the lessor, beginning on January 1, 2014.
6. The lessee’s incremental borrowing rate is 12%. The lessor’s implicit rate is 10% and is known to the lessee.
7. Plote Company uses the straight-line depreciation method for all equipment.
8. Plote uses reversing entries when appropriate.

Answer 1

Step:1) Identify the Lease:

Since Lease Period 5 years covers entire Economic useful life of equipment the Lease shall be treated as Finance Lease

Calculation of Present Value of Lease Payments:

Year End	Lease Rentals	Discount@10%	Present value
0	20952.04	1	20952.04
1	20952.04	0.9091	19047.31
2	20952.04	0.8264	17315.74
3	20952.04	0.7513	15741.58
4	20952.04	0.6830	14310.53
Total			$87367.19

Fair value of Euipment = $91,900 Therefore $87367.19/91900 = 95%

Present value covers substantially Intial Fair value of Lease asset therefore Lease is Finance Lease

Accounting Treatment: Lessee has to account for Leased asset at Initial fair value and account for depreciation over the lease period

2)Amortisation Schedule:
	Opening	Interest	Lease	Principal	Closing
Year	Balance	Expense	Payment	Payment	Balance
1	66415.15	6641.52	20952.04	14310.53	52104.63
2	52104.63	5210.46	20952.04	15741.58	36363.05
3	36363.05	3636.30	20952.04	17315.74	19047.31
4	19047.31	1904.73	20952.04	19047.31	0.00

3) Journal Entries

Date	Account Name	Debit($)	Credit($)
01.01.2014	Euipment	89749.19
	Lease Liability		66415.15
	Cash		23334.04
	The equipment account is debited by the present value of the minimum lease payments and the lease liability account is the difference between the value of the equipment and cash paid at the beginning of the year for Insurance and Property taxes
31.12.2014	Depreciation	17949.84
	Acc. Depreciation		17949.84
	Depreciation provided on straight line basis for 5 years(89749.19/5)
31.12.2014	Interest Expense	6641.52
	Interest Payable		6641.52
	Interest provided for year ended 2014
01.01.2015	Interest Payable	6641.52
	Lease Liability	14310.525
	Cash		20952.04
	Principal and Interest payment made