George Company manufactures a check-in kiosk with an estimated economic life of

Question

George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is $278,072, and its unguaranteed residual value at the end of the lease term is estimated to be $20,000. National will pay annual payments of $40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of $180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

(a) Discuss the nature of this lease in relation to the lessee and compute the amount of the initial lease liability.

(b) Prepare a 10-year lease amortization schedule.
(c) Prepare all of the lessee’s journal entries for the first year.

Explanation / Answer

Part a)

The lease will be classified as a "Sales Type Lease". It is so because the lease term of the asset is more than 75% of the economic life of the asset. Secondly, there is a reasonable assurance as to the collectibility of the lease payments with no additional costs to be incurred. Thirdy, George Company was able to realize a portion of the profit besides the financing charge.

__________

Part a-1)

The value of lease receivable is calculated as follows:

__________

Part a-2)

The sale price is calculated as follows:

__________

Part a-3)

The cost of sales is calculated as follows:

__________

Part b)

The amortization schedule is given below:

__________

Part c)

The journal entries for the first year are as follows:

Annual Lease Payment (A) 40,000 Present Value Interest Factor of Annuity Due at 10% for 10 Periods (B) 6.75902 Present Value of Rental Payments (A*B) 270,361 Add Present Value of Residual Value (20,000*.38554) 7,711 Lease Receivable $278,072

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