Problem 21-1 Glaus Leasing Company agrees to lease machinery to Jensen Corporati

Question

Problem 21-1 Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2014. 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 $548,000, and the fair value of the asset on January 1, 2014, is $718,000.

3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $134,000. Jensen depreciates all of its equipment on a straight-line basis.

4. The lease agreement requires equal annual rental payments, beginning on January 1, 2014.

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. Glaus desires a 11% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31.)

a. Prepare the journal entries Jensen would make in 2014 and 2015 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

b.Prepare the journal entries Glaus would make in 2014 and 2015. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

Explanation / Answer

Here as rate of return and incremental borrowing is same so total of annual lease payment and MLP is also same

Its a sale type lease as fair value of equipment exceeds cost of the equipment.

In the books of Jensen Date Accounts Title Dr Cr 1/1/2014 Leased Equipment $718,000 Leased Liability $718,000 ( being lease recognized in the books) 1/1/2014 Lease liability 124931 Cash 124931 (Being annual lease payment made) 12/31/2014 Depreciation Expense 92429 Accumulated depreciation-Capital Lease 92429 (781000-134000)/7 12/31/2014 Interest Expense 65238 Interest payable 65238 (718000-124931)*11% (Being interest expenses accured) 1/1/2015 Lease liability 59693 Interest Payable 65238 Cash 124931 (Being annual lease payment made) 12/31/2014 Depreciation Expense 92429 Accumulated depreciation-Capital Lease 92429 (781000-134000)/7 12/31/2014 Interest Expense 58671 Interest payable 58671 (718000-124931-59693)*11% (Being interest expenses accured) In the books of Glaus 1/1/2014 Dr Cr Lease Receivable 718000 Cost of Good Sold 548000 Sales Revenue 718000 Inventory 548000 (being lease recorded in the books of lessor) 1/1/2014 Cash 124931 Lease Receivable 124931 (Being cash received of annual lease ) 31/12/2014 Interest Receivable 65238 Interest revenue 65238 (same amout as of lessee amount as the rate is same in this case for both 11%) 1/1/2015 Cash 124931 Lease Receivable 59693 Interest Receivable 65238 (being annual lease payment received) 31/12/2015 Interest Receivable Interest revenue 58671 (718000-124931-59693)*11% 58671 Annual Lease payment Fair Value 718000 Less: PV of guarnteed residual value in 7th year (134000*.4817) 64547.8 0.5136 Sub total   A 653452.2 68822.4 PV of annuity due for 7 years payment is in the beginning of the year 1+4.2305      B 5.2305 5.355 Annual Lease payment 124931 122026.6 Present value of Minimum Lease payment 124931*5.2305 653452.2 PV of guarnteed residual value 64547.8 Total 718000

Here as rate of return and incremental borrowing is same so total of annual lease payment and MLP is also same

Its a sale type lease as fair value of equipment exceeds cost of the equipment.

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