Question

On January 1, 2018, Allied Industries leased a high-performance conveyer to Karrier Company for a four-year period ending December 31, 2021, at which time possession of the leased asset will revert back to Allied. The equipment cost Allied $929,000 and has an expected useful life of five years. Allied expects the residual value at December 31, 2022, will be $313,000. Negotiations led to the lessee guaranteeing a $366,000 residual value.

Equal payments under the finance/sales-type lease are $213,000 and are due on December 31 of each year with the first payment being made on December 31, 2018. Karrier is aware that Allied used a 6% interest rate when calculating 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. Prepare the appropriate entries for both Karrier and Allied on January 1, 2018, to record the lease.

2. Prepare all appropriate entries for both Karrier and Allied on December 31, 2018, related to the lease.

Answer 1

Journal entries in the Books of Karrier (Lessee)
Sl. No	Date	Particulars	Ref	Dr/Cr	Amount
1	01-Jan-18	High Performance Conveyor		Dr.	929,000
		To Allied Industries		Cr	(929,000)
	Being High performance conveyor taken and acquired on lease
2	31-Dec-18	Interest Expense A/c		Dr	83,231
		To Allied Industries		Cr	(83,231)
		Being Interest Expense for the Period Recognised
3	31-Dec-18	Depreciation Expenses		Dr	232,250
		To High Performance Conveyor		Cr	(232,250)
		Being Depreciation expense for the period recognised
4	31-Dec-18	Allied Industies		Dr	213,000
		To Bank		Cr	(213,000)
		Being Lease Installment for Year-1 Paid

Journal entries in the Books of Allied (Lessor)
Sl. No	Date	Particulars	Ref	Dr/Cr	Amount
1	01-Jan-18	Karrier(Lessee) A/c		Dr	929,000
		To High Performance Conveyor		Cr	(929,000)
		Being High Performance conveyor leases under finance type
2	31-Dec-18	Karrier(Lessee) A/c		Dr	55,740
		To interest Income		Cr	(55,740)
3	31-Dec-18	Bank A/c		Dr	213,000
		To Karrier(Lessee) A/c		Cr	(213,000)

Notes :

1. Interest rate implicit in the Lease is PVIFA(121,8000)= -929,000 (ie IRR = 8.96%)

From Lessee Stand Point of View
year no	Principal Opening	Interest @8.96%	Principal Repayment	Principal Outstanding
1	929,000	83,231	129,769	799,231
2	799,231	71,604	141,396	657,835
3	657,835	58,937	154,063	503,772
4	503,772	45,134	167,866	335,906

2. From Lessor stand point it is assumed that the 6% is the financing component, hence present value at 6% is used

From Lessor stand point of View
Sl. No	Principal	Interest @6%	Principal Repayment	Principal Outstanding
1	929,000	55,740	157,260	771,740
2	771,740	46,304	166,696	605,044
3	605,044	36,303	176,697	428,347
4	428,347	25,701	187,299	241,048