Question

Sheffield Leasing Company agrees to lease equipment to Tamarisk Corporation on January 1, 2020. The following information relates to the lease agreement.

1.		The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
2.		The cost of the machinery is $483,000, and the fair value of the asset on January 1, 2020, is $757,000.
3.		At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $55,000. Tamarisk estimates that the expected residual value at the end of the lease term will be 55,000. Tamarisk amortizes all of its leased equipment on a straight-line basis.
4.		The lease agreement requires equal annual rental payments, beginning on January 1, 2020.
5.		The collectibility of the lease payments is probable.
6.		Sheffield desires a 10% rate of return on its investments. Tamarisk’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31.)

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Discuss the nature of this lease for both the lessee and the lessor.

This is a _________for Tamarisk.

This is a _________ for Sheffield.

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Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,972.)

Annual rental payment

$

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Compute the value of the lease liability to the lessee. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,972.)

Present value of minimum lease payments

$

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Prepare the journal entries Tamarisk would make in 2020 and 2021 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,972. Record journal entries in the order presented in the problem.)

Date	Account Titles and Explanation	Debit	Credit
1/1/2012/31/201/1/2112/31/21
	(To record the lease.)
	(To record lease payment.)
1/1/2012/31/201/1/2112/31/21
	(To record amortization.)
	(To record interest.)
1/1/2012/31/201/1/2112/31/21
1/1/2012/31/201/1/2112/31/21
	(To record amortization.)
	(To record interest.)

Answer 1

Solution:

1. For both the lessor and the lessee its a capital lease, as the PV of lease payments exceed 90% of the fair value of the leased asset.

2. Annual Rental Payment = 136086

Fair Value of the asset	757000
Less: PV of the residual value ($55000*.51316)	28224
Amount to be recovered Through periodic lease payments	728776
Lease Payments at the beginning of each of the next seven years ($728776÷ 5.35526)	136086

3. Lease liability for the lessee = $738295

Lease Liability
PV of Lease Payments
Lease Payment	136086
No of periods	7
Interest rate per period	11%
PV annuity due Factor @ 11% for 7 years	5.23054
PV of Lease Payments	711803
PV of Residual Value of $55,000	₹ 26,491.21
PV of Minimum Lease Payments	738295

	Journal Entries - In Lessee Books - Tamarisk
Jan 01 2020	Right to use Asset	738295
	Lease Liability		738295
	(To record Liability)
Jan 01, 2020	Lease Liability	136086
	Cash		136086
	(To record lease payments)
31-Dec-20	Interest Expense	66243
	Interest Payable		66243
	( To record accrued interest)
	Depreciation Expense	97614
	Accumulated Depreciation - Right-to- Use Asset		97614
	(To record Depreciation Expense = (738295 - 55000)/4
Jan 01 2021	Interest Payable	66243
	Interest Expense		66243
	(Reversing the entry)
	Interest Expense	66243
	Lease Liability	69843
	Cash		136086
	To record lease payment
31-Dec-2021	Interest Expense	58560
	Interest Payable		58560
	( To record accrued interest)
	Depreciation Expense	97614
	Accumulated Depreciation - Right-to- Use Asset		97614
	(To record Depreciation Expense)