Question

On April 1, 2020, Benintendi enters into a 5-year, non-cancelable lease with Fenway Inc for use of a hitting machine requiring payments of $20,000 every March 31 (1^st payment is due today). Fenway requires that the asset at the end of 5 years is returned with a guaranteed residual value of no less than $9,006.

The asset has a fair value of $100,000 and an 8-year useful life. Benintendi’s incremental borrowing cost is 6.5% but Fenway seeks a 4% return from this lease.

The lease has no renewal options and the asset will revert back to Fenway at the end of the 5 years.

PV of annuity due at 4% for 5 years = 4.629895 and PV of lump sum at 4% for 5 years is .821927

Required:

1. Determine if this lease is a financing or operating lease.
2. Calculate the present value of the lease agreement.
3. Make the original entry on both sets of books on April 1, 2020.
4. Create the amortization table for year one only.
5. Make the required March 31, 2021 journal entries for both sets of books.

Answer 1

Requirement 1:  This lease is considered to be Financial lease.

Under U.S. GAAP, lease is to be considered as Financial (or capital) lease if any one of four conditions must be met

a)Transfer of ownership of the asset at the end of the lease term.

b)An option to purchase the asset at a discounted price at the end of the term.

c)The term of the lease is greater than or equal to 75% of the useful life of the asset.

d)The present value of the lease payments is greater than or equal to 90% of the asset’s fair market value.

In this question 4th criteria has been met i.e PV of lease payment is greater than 90% of assets fair market value. Therefore it is considered as a finacial lease.

Requirement 2: PV of the lease payment = Periodical payment*PV of annuity due at the end of lease period + PV of Any other guarenteed payment made at the end of lease period

20,000*4.629895 + 9006*.821927 =92598 + 7402= $100,000

Requirement 3 and 5:

Journal entry in lessee book -

on 31st march 2020:

a)capital lease recorded at present value-

Debit Right of use asset 92598

Credit lease liability 92598

b)Initial payment made on capital lease-

Debit lease liability 20000

Credit Cash 20000

On 1st april 2020-

a) lease liability due:

Debit Rent Expense 20000

Credit Right of use asset 15281

Credit Lease Liability (Accrete inetest) 4719

On 31st march 2021-

a) Depreciation charged on asset by straight line method= 100000-9006/5=18199

Debit Depreciation expense 18199

Credit Accumulated Depreciation 18199

b) Interest on lease liability and 2nd payment made=

Debit Lease Liability 15281

Debit Interest payment 4719

Credit Cash    20000

Journal entry in lessor book-

On 31st march 2020-

a)Initial entry-

Debit Lease Receivable 92598

Credit Asset 92598

b)On receipt of 1st payment-

Debit Cash 20000

Credit Lease receivable 20000

On 1st april 2021-

a) Lease Rent due-

Debit Lease Receivable 80000

Credit Asset 80000

On 31st march 2021-

a) On receipt of 2nd payment-

Debit Cash 20000

Credit Finance income 4719

Credit Lease receivable 15281

Requirement 4: Calculations for Amortisation Schedule-

For year 0- Payment on 31st march 2020=20000 and closing balance is 92598-20000=72598.

For year 1-payment date- 31st march 2021

Opening Balance= 72598

Total payment for year 1 =20000

Interest expense= 72598*6.5%=4719

NOTE: Interest is always calculated on Opening balance at the starting of any period.

Principal repayment= Total Payment- Interest expense=20000-4719= 15281

Closing Balance= Opening balance - Principal repayment for year 1 = 72598-15281=57317

Amortisation Schedule:

Payment No.	Payment Date	Opening Balance	Total Payment	Intersest Expense	Principal Repayment	Closing Balance
Year 0	31st march 2020	92598	20000	0	20000	72598
Year 1	31st march 2021	72598	20000	4719	15281	57317