Kingbird Leasing Company agrees to lease machinery to Oriole Corporation on Janu
ID: 2438149 • Letter: K
Question
Kingbird Leasing Company agrees to lease machinery to Oriole Corporation on January 1, 2017. The following information relates to the lease agreement.
(Assume the accounting period ends on December 31.)
a. Calculate the amount of the annual rental payment required.
b. Compute the present value of the minimum lease payments.
c. Prepare the journal entries Oriole would make in 2017 and 2018 related to the lease arrangement.
d. Prepare the journal entries Kingbird would make in 2017 and 2018.
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 $500,000, and the fair value of the asset on January 1, 2017, is $659,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $103,000. Oriole depreciates all of its equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Kingbird desires a 9% rate of return on its investments. Oriole’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.Explanation / Answer
Part a:
Year
Present value factor @9% per annum
0
1
1
0.917431
2
0.84168
3
0.772183
4
0.708425
5
0.649931
6
0.596267
7
0.547034
Particulars
Amount ($)
Thus, present value of residual value (103000 x 0.547034)
56344.53
Fair value of the machine as on January 01, 2017
659000
Less: Present value of residual value
56344.53
Amount to be recovered from lease rent
602655.5
Present value factor for year 0 to 6 at the rate of 9% per annum
5.485919
Thus, annual lease rent should be (602655.50 / 5.485919)
($) 109855
Part b:
Particulars
Amount ($)
Present value of minimum lease payment
Present value of annual lease rent (109855 x 5.485919)
602655.5
Add: present value of residual value (103000 x 0.547034)
56344.53
Present value of minimum lease payment
659000
Part c:
Date
Account titles and explanations
`Debit ($)
Credit ($)
01-01-17
Machine
659000
Kingbird Leasing Company
659000
(Being the lease recorded at the present value of lease)
01-01-17
Kingbird Leasing Company
109855
Bank
109855
(Being the first lease payment made)
31-12-17
Interest on lease (659000-109855) x 9%
49423.05
Kingbird Leasing Company
49423.05
(Being the interest on lease charged)
31-12-17
Depreciation (659000 x 1/7)
94142.86
Machine
94142.86
(being the depreciation provided)
31-12-17
profit and loss account
143565.9
Interest on lease (659000-109855) x 9%
49423.05
Depreciation (659000 x 1/7)
94142.86
(being the depreciation and interest charged against the profit and loss of the company)
01-01-18
Kingbird Leasing Company
109855
Bank
109855
(Being the first lease payment made)
31-12-18
Interest on lease {(659000-109855)+49423} x 9%
53871.13
Kingbird Leasing Company
53871.13
(Being the interest on lease charged)
31-12-18
Depreciation (659000 x 1/7)
94142.86
Machine
94142.86
(being the depreciation provided)
31-12-18
profit and loss account
148014
Interest on lease {(659000-109855)+49423} x 9%
53871.13
Depreciation (659000 x 1/7)
94142.86
(being the depreciation and interest charged against the profit and loss of the company)
Part d:
Date
Account titles and explanations
`Debit ($)
Credit ($)
01-01-17
Oriole Corporation
659000
Machine
659000
(being lease provided)
01-01-17
Bank
109855
Oriole Corporation
109854.979
(being the lease rental received)
31-12-17
Oriole Corporation (659000-109855) x 9%
49423.05
Interest on lease (659000-109855) x 9%
49423.0519
(Being interest on outstanding amount charged)
31-12-17
Interest on lease (659000-109855) x 9%
49423.05
profit and loss account
49423.0519
(being interest credited)
01-01-18
Bank
109855
Oriole Corporation
109854.979
(being the lease rental received)
31-12-18
Oriole Corporation {(659000-109855)+49423} x 9%
53871.13
Interest on lease {(659000-109855)+49423} x 9%
53871.129
(Being interest on outstanding amount charged)
31-12-18
Interest on lease {(659000-109855)+49423} x 9%
53871.13
Profit and loss account
53871.129
(being interest credited)
Year
Present value factor @9% per annum
0
1
1
0.917431
2
0.84168
3
0.772183
4
0.708425
5
0.649931
6
0.596267
7
0.547034
Particulars
Amount ($)
Thus, present value of residual value (103000 x 0.547034)
56344.53
Fair value of the machine as on January 01, 2017
659000
Less: Present value of residual value
56344.53
Amount to be recovered from lease rent
602655.5
Present value factor for year 0 to 6 at the rate of 9% per annum
5.485919
Thus, annual lease rent should be (602655.50 / 5.485919)
($) 109855
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