E21-7B (L02,3,4) (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, G

Question

E21-7B (L02,3,4) (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, Global Corporation leased equipment to Local Inc. The following information pertains to this lease.

1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termina- tion of the lease.

2. Equal rental payments are due on January 1 of each year, beginning in 2017.
3. The fair value of the equipment on January 1, 2017, is $320,000, and its cost is $265,000.
4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $30,000. Local depreciates all of its

equipment on a straight-line basis.
5. Global set the annual rental to ensure a 12% rate of return. Local’s incremental borrowing rate is 10%, and the implicit rate

of the lessor is unknown.
6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs

yet to be incurred by the lessor.

Instructions

(a) Calculate the amount of the annual rental payment.

(b) Discuss the nature of this lease to Global and Local.

(c) Prepare all the necessary journal entries for Local for 2017.

(d) Prepare all the necessary journal entries for Global for 201

Explanation / Answer

Solution:

a.

Annual rental payment = ($320,000 - $30,000 x0.50663*) /4.1114**

Annual rental payment = $74,135.46

*Present value of $1 at 12% for 6 years

**Present value of an annuity due at 12% for 6 years

b. It is a capital lease to Local since the lease term is 75% (6/8) of the asset's economic life, Also, the present value of the minimum lease payments is greater than 90% of the fair value of the asset. It is a capital lease to Global since collectibility of the lease payment is predictable, there are unimportant uncertainities of the cost to be incurred by the lessor and lease term is 75% of the asset's economic life. Because the fair value of the equipment ($320,000) exceeds the lessor's cost ($265,000), the lease is a sales type lease.

c. 1/1/17

Leased Equipment Under Capital Leases....................................................... 322,879

Lease Liability ......................................................... 322,879

($74,135.46 X 4.25536)***

Lease Liability.......................................74,135.46

Cash....................................................... 74,135.46

***Present value of an annuity due at 10% for 6 periods.

12/31/17

Depreciation Expense .............................. 53,813

Accumulated Depreciation ............ 53,813 ($322,879 ÷ 6 years)

Interest Expense ........................................ 41,457

Interest Payable................................. 41,457 ($322,879 – $74,135) X .10

(d) 1/1/17

Lease Receivable.................................. 320,000*

Cost of Goods Sold.............................. 249,801**

Sales ................................................ 304,801***

Inventory......................................... 265,000 *

*($74,135 x 4.1114) + ($30,000 x .50663), rounded

**$265,000 – ($30,000 x .50663)

***$74,135 X 4.1114, rounded

Cash.......................................................... 74,135

Lease Receivable......................... 74,135

12/31/17 Interest Receivable .............................. 29,504

Interest Revenue.......................... 29,504  

[($320,000 – $74,135) X .12]

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.