Flounder Leasing Company agrees to lease machinery to Culver Corporation on Janu

Question

Flounder Leasing Company agrees to lease machinery to Culver Corporation on January 1, 2017. The following information relates to the lease agreement.

(Assume the accounting period ends on December 31.)

Prepare the journal entries Culver would make in 2017 and 2018 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.)

Date

Account Titles and Explanation

Debit

Credit

(To record the lease.)

(To record lease payment.)

(To record depreciation.)

(To record interest.)

1/1/18

(To record depreciation.)

(To record interest.)

Prepare the journal entries Flounder would make in 2017 and 2018. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,971.)

Date

Account Titles and Explanation

Debit

Credit

1/1/17

(To record the lease.)

(To record lease payment.)

1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2. The cost of the machinery is $495,000, and the fair value of the asset on January 1, 2017, is $704,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $96,000. Culver depreciates all of its equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Flounder desires a 9% rate of return on its investments. Culver’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.

Explanation / Answer

Part 1)

We will have to calculate the present value of annual payments, amount of lease payment and present value of minimum lease payments as below:

_____

Annual Lease Payment = Present Value of Annual Payments/5.48592 (with the use of Present Value of Annuity Due Tables at 9% for 7 Years) = 651,485/5.48592 = $118,756

_____

_____

The journal entries in the books of Culver for 2017 and 2018 are prepared as below:

_____

Part 2)

The journal entries in the books of Flounder for 2017 and 2018 are provided as follows;

Total Amount to be Recovered 704,000 Less Present Value of Guaranteed Residual Value (96,000*.54703) 52,515 Present Value of Annual Payments $651,485

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