Question

Course: Accounting of financial institutions

Q2. Pass journal entries in the books of lessor in case of capital lease only for the first year under sale- type lessor method.

The instructor want us to give imaginary numbers and pass journal entries for it

Answer 1

In a sales type lease, the PV of cash flows is accounted immediately upon the inception of the lease, with the remainder accounted for over the term of the lease period. The lessor should recognize the gross profit from the lease immediately upon the start of the lease. The gross profit is calculated as the PV of the future cash flows from the lease less the book value of the asset at the start of the lease, discounted at the internal rate of return. The lessor no longer shows the asset on its balance sheet.

For example, if the book value of the asset id $ 10,000 and the cash flows over the lease period of 5 years is $ 3,000 per year. The discount rate is 5%.

The discounted cash flows will be $ 2,857, $ 2,721.09, $ 2,591.51, $ 2,468.11 & $ 2,350.58 respectively for 5 years

Therefore, the gross profit will be the difference between the sum of the discounted CFs and the book value of asset.

Gross Profit = $ 12,988.43 - $ 10,000 = $ 2,988.43

Journal entry:

Lease receivable a/c Dr 12,988.43

   Aset a/c Cr 12,988.43

Also, gross profit of $ 12,988.43 has to be recorded in P/L