In: Accounting
Bullwinkle Corp. leased medical equipment from Rocky Co., signing a lease agreement that stipulates annual payments of $250,000 on January 1 of each year for a five-year period. The first payment is due at the signing of the lease transaction on 1/1/17.
Rocky Co. set an implicit rate of 6% in the terms of the agreement, which is equal to the incremental borrowing rate of Bullwinkle Corp. Rocky has also stipulated a residual value of $400,000 at the end of the lease term. Bullwinkle is not required to guarantee it.
There is no transfer or ownership and the lease is noncancellable. The fair value of the leased equipment is $1,415,180 and the equipment cost Rocky Co. $800,000 to manufacture. It has a useful life of 10 years.
Classify the lease and provide evidence to substantiate your classification decision.
1. Provide journal entries for both lessee and lessor at the inception of the lease (1/1/17).
2. Provide journal entries to record the necessary adjustments at year-end, 12/31/17.
3. Provide journal entries to record the payment of cash on 1/1/17.
4. Provide new journal entries adjusting the lease contract on 12/31/17 if the $400,000 guaranteed residual value were set to $1,000,000 (assume all other information regarding the lease contract remains constant).
The lease will be classified as Operating Lease:
Part1:
In the Books of Lessee | |||
Date | Account description | Debit | Credit |
1-Jan | Right to Use Assets | 1,116,276 | |
Lease Obligation | 866,276 | ||
Cash | 250,000 | ||
(Being Lease Recorded) |
In the Books of Lesser | |||
Date | Account description | Debit | Credit |
1-Jan | Lease Receivable | 866,276 | |
Cash | 250,000 | ||
Residual Assets | 298,903 | ||
Lease Assets | 800,000 | ||
Deferred Gross Profit | 615,180 | ||
(Being Lease Recorded) |
Workings:
Present Value of Lease Cashflow | |||
Cashflow | PV Factor | Present Value | |
0 | 250,000 | 1 | 250,000 |
1 | 250,000 | 0.943396 | 235,849 |
2 | 250,000 | 0.889996 | 222,499 |
3 | 250,000 | 0.839619 | 209,905 |
4 | 250,000 | 0.792094 | 198,023 |
5 | 0.747258 | - | |
1,116,276 |
Part 2:
In the Books of Lessee | |||
Date | Account description | Debit | Credit |
31-Dec | Lease Expenses | 250,000 | |
Right to Use Assets | 198,023 | ||
Lease Obligation | 51,977 | ||
(Being Lease Expenses Recognised) |
In the Books of Lesser | |||
Date | Account description | Debit | Credit |
31-Dec | Lease Receivable | 51,977 | |
Residual Assets | 17,934 | ||
Deferred Gross Profit | 10,089 | ||
Interest Income | 80,000 | ||
(Being Lease Revenue Recognised) |
Workings:
Amortization Table | ||||
Lease Expenses | Interest | Lease Obligation | Amortization | |
0 | 250,000 | 866,276 | ||
1 | 250,000 | 51,977 | 668,253 | 198,023 |
2 | 250,000 | 40,095 | 458,348 | 209,905 |
3 | 250,000 | 27,501 | 235,849 | 222,499 |
4 | 250,000 | 14,151 | (0) | 235,849 |
5 | - | (0) | (0) | 250,000 |
Part 3:
In the Books of Lessee | |||
Date | Account description | Debit | Credit |
1-Jan | Lease Obligation | 250,000 | |
Cash | 250,000 | ||
(Being Lease Rental Paid) |
In the Books of Lesser | |||
Date | Account description | Debit | Credit |
1-Jan | Cash | 250,000 | |
Lease Receivable | 250,000 |
Part 4:
In the Books of Lessee | |||
Date | Account description | Debit | Credit |
31-Dec | Right to Use Assets | 747,258 | |
Lease Obligation | 747,258 | ||
31-Dec | Lease Expenses | 250,000 | |
Right to Use Assets | 153,188 | ||
Lease Obligation | 96,812 |
In the Books of Lesser | |||
Date | Account description | Debit | Credit |
1-Jan | Lease Receivable | 747,258 | |
Deferred Gross Profit | 448,355 | ||
Residual Assets | 298,903 | ||
31-Jan | Lease Receivable | 96,812 | |
Deferred Gross Profit | 16,812 | ||
Interest Income | 80,000 |
Workings:
Present Value of Lease Cashflow | |||
Cashflow | PV Factor | Present Value | |
0 | 250,000 | 1 | 250,000 |
1 | 250,000 | 0.943396 | 235,849 |
2 | 250,000 | 0.889996 | 222,499 |
3 | 250,000 | 0.839619 | 209,905 |
4 | 250,000 | 0.792094 | 198,023 |
5 | 1,000,000 | 0.747258 | 747,258 |
1,863,535 |
Amortization Table | ||||
Lease Expenses | Interest | Lease Obligation | Amortization | |
0 | 250,000 | 1,613,535 | ||
1 | 250,000 | 96,812 | 1,460,347 | 153,188 |
2 | 250,000 | 87,621 | 1,297,967 | 162,379 |
3 | 250,000 | 77,878 | 1,125,846 | 172,122 |
4 | 250,000 | 67,551 | 943,396 | 182,449 |
5 | - | 56,604 | 1,000,000 | 193,396 |