E21-4B (Lessor Entries; Direct-Financing Lease with Option to Purchase) Power To

Question

E21-4B (Lessor Entries; Direct-Financing Lease with Option to Purchase) Power Top Leasing signs a lease agreement on January 1, 2014, to lease power equipment to Manual Bottoms Company. The term of the noncancelable lease is 4 years, and payments are required at the end of each year. The following information relates to this agreement:

1. Manual Bottoms Company has the option to purchase the equipment for $25,000 upon the termination of the lease.

2. The equipment has a cost and fair value of $325,000 to Power Top Leasing. The useful economic life is 5 years, with a salvage value of $25,000.

3. Manual Bottoms Company is required to pay $2,000 each year to the lessor for executory costs.

4. Power Top Leasing desires to earn a return of 12% on its investment.

5. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

B EXERCISES

PLEASE SHOW YOUR WORK. This question is for intermediate accounting. Authors kieso, weygandt, and warfield

Instructions

(a) Prepare the journal entries on the books of Power Top Leasing to reflect the payments received under the lease and to recognize income for the years 2014 and 2015.

(b) Assuming that Manual Bottoms Company exercises its option to purchase the equipment on December 31, 2017, prepare the journal entry to reflect the sale on Power Top Leasing’s books.

Explanation / Answer

1. Caculation of Annual lease payment

Let annual lease payment = X

Fair value = Present value of MLP from stand point of lessor +Guranteed residual value

325000 = X* 3.037+ 25000 * 0.636

X = 101778

Journal entries in the books of Power Top Leasing

Year 2014

1. Lease receivable Dr. 325000

To Power equipment 325000

2. Bank Dr. 2000

To Executory cost 2000

3. Bank 101778

To finance income 39000

To lease receivable 62778

4. finance income 39000

To profit and loss account 39000

Year 2015

1. Bank Dr. 2000

To Executory cost 2000

2. Bank 101778

To finance income 31467

To lease receivable 70311

3. finance income 31467

To profit and loss account 31467

Manual Bottoms Company exercises its option to purchase the equipment on December 31, 2017

Asset 25000

To lessor 25000

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