Question

On December 31, 2018, Rhone-Metro Industries leased equipment to Western Soya Co. for a four-year period ending December 31, 2022, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost Rhone-Metro $365,760 and has an expected useful life of six years. Its normal sales price is $365,760. The lessee-guaranteed residual value at December 31, 2022, is $25,000. Equal payments under the lease are $100,000 and are due on December 31 of each year. The first payment was made on December 31, 2018. Western Soya’s incremental borrowing rate is 12%. Western Soya knows the interest rate implicit in the lease payments is 10%. Both companies use straight-line depreciation. Use (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1. Show how Rhone-Metro calculated the $100,000 annual lease payments.
2. How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries (the lessor)?
3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2018.
4. Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and the lessor.
5. Prepare all appropriate entries for both Western Soya and Rhone-Metro on December 31, 2019 (the second lease payment and depreciation).
6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2022 assuming the equipment is returned to Rhone-Metro and the actual residual value on that date is $1,500.

Answer 1

1
Let X = Amount of each annual payment
PVAF @ 10% for 4 years = 3.48685
Residual Value = 0.68301*25000	17075
3.48685X + 17,075 = 365,760
X = 348,685 / 3.48685    = 100,000
2
sales-type because cost and fair market value are not equal
3
Western Soya Co. (Lessee)
Leased Asset	348685
Lease payable		348685
100000*3.48685
Lease payable	100000
Cash		100000
Rhone-Metro (Lessor)
Lease receivable	365760
Cost of goods sold 365760-17075	348685
Sales 365760-17075		348685
Equipment		365760
Cash	100000
Lease Receivable		100000

4
Date	Payment	Interest @ 10%	Principal	Balance
12/31/2022				365,760
12/31/2022	100000	-	100,000	265,760
12/31/2023	100000	26,576	73,424	192,336
12/31/2024	100000	19,234	80,766	111,570
12/31/2025	100000	11,157	88,843	22,727
12/31/2026	25000	2,273	22,726	0
4
Date	Payment	Interest @ 10%	Principal	Balance
12/31/2022				348,685
12/31/2022	100000	-	100,000	248,685
12/31/2023	100000	24,869	75,132	173,554
12/31/2024	100000	17,355	82,645	90,909
12/31/2025	100000	9,091	90,909	(0)

5.Western Soya
Lease payable	75,132
Interest expense	24,869
Cash		100,000
Depreciation expense	87,171
Accumulated depreciation		87,171
348685/4
Rhone-Metro
Cash	100,000
Lease Receivable		73,424
Interest revenue		26,576
6
Western Soya
Depreciation expense	87,171
Accumulated depreciation		87,171
Accumulated depreciation	348,685
Leased asset		348,685
Rhone-Metro
Aaset	1500
Loss on leased asset 25000-1500	23500
Lease receivable		22726
Interest revenue		2274