Question

On December 31, 2018, Yard Art Landscaping leased a delivery truck from Branch Motors. Branch paid $40,000 for the truck. Its retail value is $45,114.

The lease agreement specified annual payments of $11,000 beginning December 31, 2018, the beginning of the lease, and at each December 31 through 2021. Branch Motors’ interest rate for determining payments was 10%. At the end of the four-year lease term (December 31, 2022) the truck was expected to be worth $15,000. The estimated useful life of the truck is five years with no salvage value. Both companies use straight-line amortization or depreciation.

Yard Art guaranteed a residual value of $6,000. Yard Art’s incremental borrowing rate is 9% and is unaware of Branch’s implicit rate.

A $1,000 per year maintenance agreement was arranged for the truck with an outside service firm. As an expedient, Branch Motors agreed to pay this fee. It is, however, reflected in the $11,000 lease payments. (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. How should this lease be classified by Yard Art Landscaping (the lessee)?
2. Calculate the amount Yard Art Landscaping would record as a right-of-use asset and a lease liability.
3. How should this lease be classified by Branch Motors (the lessor)?
4. Show how Branch Motors calculated the $11,000 annual lease payments.
5. Calculate the amount Branch Motors would record as sales revenue.
6. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2018.
7. Prepare an amortization schedule that describes the pattern of interest expense over the lease term for Yard Art.
8. Prepare an amortization schedule that describes the pattern of interest revenue over the lease term for Branch Motors.
9. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2019.
10. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2021 (the final lease payment).
11. Prepare the appropriate entries for both Yard Art and Branch Motors on December 31, 2022 (the end of the lease term), assuming the truck is returned to the lessor and the actual residual value of the truck was $4,000 on that date.

Answer 1

1. Lease will be classified as Capital Lease since Lease Term 4 Years covers maimum of Economic life of Truck 5 Year. (i.e. More than 75% of economic life).

2. Right of Use asset and Lease Liability: Since Lessee is unaware of Lessor implicate rate (given in question), will take incremental borrowing 9% of lesse as discount

Present Value of Lease payment	Excluding Maintenance Cost	(11000-1000)*3.5313	35313
		(9% 4 year PV)
Present Value of Guranteed Residual Value		6000*0.7084	4251
Lease Liability and Righ tot Use			39564

3. For Lessor, it will be Direct Financing Capital Lease. Capital Lease as mentioned in Part-1. Direct Financing since there is not dealer profit, Branch bought it lower than retial price of 45114.

4.

Lessor calculation
	PV 10%	Present Value
Lease Payment (11000-1000)=10000	3.4869	34869
end of 4 year value 15000	0.683	10245
		45114