On January 1, 2016, Feldman Company enters into a noncancelable lease, with no r

Question

On January 1, 2016, Feldman Company enters into a noncancelable lease, with no renewal option, to lease a new piece of equipment from Cordova Leasing Company. The lease term is for three years and the lease payments are made on December 31 of each year.

The equipment cost Cordova $250,000, it has a fair value of $300,000 and a useful life of 10 years with no residual value. The equipment reverts to Cordova upon termination of the lease. Feldman guarantees a $100,000 residual value at the end of the lease term.

Feldman Company depreciates all machinery it owns on a straight-line basis. Feldman’s incremental borrowing rate is 8 percent per year and Feldman Company does not have knowledge of the 5 percent implicit rate used by Cordova.

Collectability of the future lease payments is reasonably predictable, and no additional costs related to the lease are expected.

Required:

1.Determine the annual lease payments, as set by the lessor.

2.Determine the amount of the minimum lease payments that will be capitalized by the lessee.

3.What type of lease is this to Feldman Company? Be specific in justifying your answer.

4.What type of lease is this to Cordova Company? Be specific in justifying your answer.

5.Prepare any necessary journal entries on January 1, 2016, for both parties.

6.Prepare any necessary journal entries on December 31, 2105 for both parties.

7.What is the amount of depreciation expense that will be recognized by the lessee? Be sure to show all calculations

Explanation / Answer

Cordova Leasing Co. 1. Annual lease payments Fair value of equipment 300000 Salvage value after 3 years guaranteed by Feldman Co. 100000 Annual lease payment (principal) 66667 Equated annual payment Incremental borrowing rate 8% Present value of salvage value 79383 Net present value of lease 220617 Annual lease payment 85607 Feldman Co. 2. Minimum lease payments that will be capitalized by lessee Fair value of equipment 300000 Salvage value 100000 Value capitalized 200000 3. This is an Operating Lease to Feldman Co. 4. This is a full and non-payout lease to Cordova Co. 5. Journal entries for both parties on 1 Jan 2016 Feldman Co. No entries are necessary on 1 Jan 2016 Cordova Co. 01-Jan-16 Feldman Co. Debit 250000 Equipment Credit 250000 (3-year lease of equipment toFeldman Co.) 6. Journal entries for both parties on 31 Dec 2016 Feldman Co. 31-Dec-16 Lease payments Debit 85607 Cash Credit 85607 (Annual lease payment) Cordova Co. 31-Dec-16 Cash Debit 85607 Feldman Co. Credit 85607 (Lease payment from Feldman Co.) Feldman Co. Debit 12500 Interest on Lease Credit 12500 (Interest @ 5% on lease) 7. Depreciation expense recognized by lessee No depreciation expense will be recognized by lessee as the equipment does not belong to them. The only cost to the lessee is the annual lease payment.

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