Hanson Company manufactures a computer with an estimated economic life of 5 year
ID: 2477764 • Letter: H
Question
Hanson Company manufactures a computer with an estimated economic life of 5 years and leases it to Flypaper Airlines on January 1, 2014, for a period of 3 years. The normal selling price of the equipment is $275,000, and its unguaranteed residual value at the end of the lease term is estimated to be $20,000. Flypaper will pay annual payments of $95,036 at the beginning of each year and all maintenance, insurance, and taxes estimated at $5,000 per year. Hanson incurred costs of $135,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. Hanson has determined that the collectibility of the lease payments is reasonably predictable and that no additional costs will be incurred. The lessee’s incremental borrowing rate is 11% and the lessor’s implicit rate is 10% (unknown to the lessee).
Required:
1. Calculate the present value of the minimum lease payments to be paid by Flypaper Airlines.
2. Prepare an amortization schedule for Flypaper Airline’s lease payments.
3. Record all entries required on Flypaper Airline’s books relating to the lease for the years ending December 31, 2014 and 2015.
4. Record the return of the equipment at December 31, 2015.
Explanation / Answer
1. The present value of the minimum lease payments to be paid.
PV = SUM[P/(1+r)n] + [RV/(1+r)n]
Where PV = Present Value
P = Annual Lease Payments = $95,036
r = Interest rate = 11%
n = number of years in the lease term = 3 years
RV = residual value = $20,000
SUM[P/(1+r)n] = the total amount paid over the lease term, discounted for the interest rate.
PV = [95,036 /(1.11)] + [95,036 /(1.11)2] + [95,036 /(1.11)3] + [20,000/(1.11)3]
=85,618 + 77,169 + 69,471 + 14,620
=$246,878 is the present value of minimum lease payments.
2. Prepare an amortization schedule for Flypaper Airline’s lease payments.
Computation of Lease Amortization Schedule:
Date
Lease payment
Interest
Lease reduction
Lease obligation balance
1/1/14
$95,036
-
$95,036
275,000
1/1/15
$95,036
30,250
64,786
201,214
1/1/16
$95,036
23,124
71,912
129,302
3. Record all entries required on Flypaper Airline’s books relating to the lease for the years ending December 31, 2014 and 2015.
. journal entries:
Date
Entry
Debit
Credit
31st Dec 2015
Computer
Lease payable account
275,000
275,000
Lease payable account
Bank
(lese rental paid)
95,036
95,036
Depreciation expense
Accumulated depreciation (275,000 - 20,000 / 3years = straight line method)
85,000
85,000
1st jan 2017
Interest Expense
Lease payable account
Bank
(lese rental paid)
30,250
64,786
95,036
Depreciation expense
Accumulated depreciation (275,000 - 20,000 / 3years = straight line method)
85,000
4. Record the return of the equipment at December 31, 2015.
Date
Lease payment
Interest
Lease reduction
Lease obligation balance
1/1/14
$95,036
-
$95,036
275,000
1/1/15
$95,036
30,250
64,786
201,214
1/1/16
$95,036
23,124
71,912
129,302
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