P 5 Fontana Company enters into a lease agreement on January 1, 2016, for equipm

Question

P 5 Fontana Company enters into a lease agreement on January 1, 2016, for equipment leased by Mindbender Insurance Company. The following data are relevant to the lease agreement The term of the non-cancellable lease is four years with no renewal or purchase options. Payments of $129,056 are due at the beginning of each year. The fair value of the equipment on January 1, 2016, and the cost to Mindbender, is $449,999. The equipment has an economic life of four years with no salvage value. Fontana And Mindbender depreciate similar machinery using the straight-line method. The lessee pays all executory costs amounting to $8,000 per year on December 31 of each year. Fontana's incremental borrowing rate and the implicit rate in the lease are both 10% per year. The lessee knows the implicit rate used in the lease computations. Mindbender has no uncertainties as to future costs and collection from Fontana. Requirements: a) Indicate the type of lease Fontana Company has entered into, and what accounting treatment is applicable b) Prepare the journal entries on Fontana's books that relate to the lease agreement for the first year of the lease term. c) Prepare the journal entries on Mindbender Insurance Company's books that relate to the lease agreement for the first year of the ease term. 101Page Anakwe-Intermediate Accounting 2, Spring 2018, Exam 2

Explanation / Answer

Since (a) the term of the lease is 4 years and is equal t the economic life of the asset, and

(b) the present value of the lease payment(421,363) is more than 90% of the fair value of the asset

the lease is a 'Capital Lease'.

The accounting treatment will be as if the asset is purchased by the lessee, whreby he will depreciate the asset and also accounts for the interest expense inbuilt in the lease rental.

The present value of the lease payment is calculated as shown below.

b.

c.

129056(1-(1/(1.10)^4)/0.10) x (1.10) 129056((1-0.683013)/0.10) x 1.10 129056(3.169865)x1.1 449999

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