Question

On January 1, 2018, Moorecraft Finance Company agreed to lease a piece of machinery to War Constructions Products, Inc. Moorecraft paid $1,493, 183 to acquire the machine from the manufacturerer and carries it at this amount in its financial statements. The fair value (current selling price) of the machine is $1,493,183. The relevant lease terms follow.

- Annual rental payments of $263,516 are due on December 31 of each year. THese payments do not include any other lease components such as insurance or property taxes.

- The lease term is 6 years.

- There is no pruchase option

- The lessor expects to recover the guaranteed residual value of $280,000 at the termination of the lease.

- The economic life of the asset is 7 years.

- The lessor's implicit rate is known to Ward Construction.

- The lessor has no material uncertainties regarding future costs to be incurred under the lease, and collectibility of lease payments is reasonably assured.

- Ward depreciates similar machinery that it owns using the straight line method. The fiscal year ends on December 31 for both companies.

REQUIRED:

a) Determine the lessor's implicit rate of return from the lease.

b) Determine the lease classification for the lessee. Support your answer with clear explanation.

c) Prepare the amortization table of the lessee for the first three years of the lease term (Date, Interest, Carrying amount of)

d) Prepare the lessee's journal entries required for the asset and lease liability for the first 2 years of thelease term ( Date, Account titles and descriptions, Debit, Credit)

Answer 1

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	Calculation of Implicit rate
Year	Receipt	Payment	Net Payment
0	1493183		1493183
1		263516	-263516
2		263516	-263516
3		263516	-263516
4		263516	-263516
5		263516	-263516
6		543516	-543516
Implicite Rate is IRR at which PV of Lease payment will be equal to Fair value
IRR	=IRR(D4:D10) i.e. year 0 to 6 for Net payment column
	6%

b. Capital Lease since Present value of lease payments are more than 90% of fair value of asset and Lease terms more then 75% of life of asset.

c.

	A	B=D or previous balance*6%	C=A-B	D=Previous Liabilit bal-Current liab reduction
Year	Payment	Interest	Liability Reduction	Liability Balance
0				1493183
1	263516	89591	173925	1319258
2	263516	79155	184361	1134897
3	263516	68094	195422	939475
4	263516	56369	207147	732328
5	263516	43940	219576	512751
6	263516	30765	232752	280000
6	280000	0	280000	0

d.

Year	S NO	Account	Debit	Credit
First year	1	Lease asset debit	1493183
		Lease Liability Credit		1493183
		(lease recorded)
First year	2	Lease Liability Debit	173925
		Interest Expense Debit	89591
		Cash		263516
		(First Lease payment)
First year	3	Depreciation	248864
		Accumulated Depreciation		248864
		(1493183/6)
Second Year	4	Lease Liability Debit	173925
		Interest Expense Debit	89591
		Cash		263516
		(First Lease payment)
Second Year	5	Depreciation	248864
		Accumulated Depreciation		248864
		(1493183/6)