Question

Universal Leasing leases electronic equipment to a variety of businesses. The company’s primary service is providing alternate financing by acquiring equipment and leasing it to customers under long-term sales-type leases. Universal earns interest under these arrangements at a 12% annual rate.
  
The company leased an electronic typesetting machine it purchased for $44,900 to a local publisher, Desktop Inc. on December 31, 2017. The lease contract specified annual payments of $9,626 beginning January 1, 2018, the beginning of the lease, and each December 31 through 2019 (three-year lease term). The publisher had the option to purchase the machine on December 30, 2020, the end of the lease term, for $26,700 when it was expected to have a residual value of $30,700, a sufficient difference that exercise seems reasonably certain. (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 Universal calculated the $9,626 annual lease payments for this sales-type lease.
2. Prepare an amortization schedule that describes the pattern of interest revenue for Universal Leasing over the lease term.
3. Prepare the appropriate entries for Universal Leasing from the beginning of the lease through the end of the lease term.

Requirement 1:

Amount to be recovered	?
?	?
Amount to be recovered through periodice lease payments	$0
Lease payments at the beginning each of three years	$9,626

Requirement 2:

Lease Amortization Table

Date	Payments	Effective Interest	Decrease in Balance	Outstanding Balance
				?
01/01/2018	?		?	?
12/31/2018	?	?	?	?
12/31/2019		?	?
12/31/2020	?
Total

Requirement 3:

- Recored the lease?

- Record cash received (January 1, 2018)

- Record cash received (December 31, 2018)

- Record cash received (December 31, 2019)

- Record cash received (December 30, 2020)

Answer 1

1) The purchase value (or amount to be recovered) of $44,900 should be equal to sum of present value of annual lease payments for three years paid at the beginning of each year and present value of purchase value option to the lessee of $26,700 after three years at the rate of 12%.

Amount to be Recovered = Annual Lease Payments*[1+PVAF(12%,2 yrs)]+Salvage value*PVF(12%,3 yrs)

$44,900 = [Annual Lease Payments*(1+1.69005)]+($26,700*0.71178)

44,900 = (Annual Lease Payments*2.69005)+19,004.53

Annual Lease Payments*2.69005 = 44,900 - 19,004.53

Annual Lease Payments = 25,895.47/2.69005 = $9,626

2) Lease amortization Schedule   (Amount in $)

Date	Payments (A)	Effective Interest (B) (Outstanding balance*10%)	Decrease in Balance (C = A-B)	Outstanding Balance
1/1/18	9,626	0	9,626	(44,900 - 9,626) = 35,274
12/31/18	9,626	(35,274*12%) = 4,233	5,393	(35,274 - 5,393) = 29,881
12/31/19	9,626	(29,881*12%) = 3,586	6,040	(29,881 - 6,040) = 23,841
12/31/20	0	(26,700 - 23,841) = 2,859	0	26,700

On December 31, 2020 there is no annual lease payment and therefore interest due for 2020 will increase the outstanding balance of $23,841 to $26,700. I have taken the interest for 2020 as the balancing figure of $2,859 to avoid rounding off difference.

3) Journal Entries for Universal leasing (Amount in $)

Date	General Journal	Debit	Credit
Jan 1, 2018	Lease Receivable	44,900
	Inventory of Equipment		44,900
Jan 1, 2018	Cash	9,626
	Lease Receivable		9,626
Dec 31, 2018	Cash	9,626
	Lease Receivable		5,393
	Interest Revenue		4,233
Dec 31, 2019	Cash	9,626
	Lease Receivable		6,040
	Interest Revenue		3,586
Dec 31, 2020	Cash	26,700
	Lease Receivable		23,841
	Interest Revenue		2,859