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Question: Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

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 \(525,000, and the fair value of the asset on January 1, 2017, is \)700,000.
3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen 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. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

(e) Prepare the journal entries Glaus would make in 2017 and 2018.

Step by step solution

01

Meaning of Lease

In exchange for one or more payments, a lessor agrees to allow a lessee to haveauthority over the use of specific property, plant, and equipment for a specified length of timeis termed a lease. Depending on whether an entity is a lessee or the lessor, there are different sorts of lease designations.

02

Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
Jan.1, 2017	Lease Receivable	700,000
	Cost of Goods Sold	525,000
	Sales Revenue		700,000
	Inventory		525,000
Jan.1, 2017	Cash	121,130
	Lease Receivable		121,130
Dec. 31, 2017	Interest Receivable	57,887
	Interest Revenue		57,887
Jan. 1, 2018	Cash	121,130
	Lease Receivable		63,243
	Interest Receivable		57,887
Dec. 31, 2018	Interest Receivable	51,563
	Interest Revenue		51,563

$$\begin{gathered} WorkingNotes: \\ CalculationofInterestRevenueonDec.31,2017 \\ Interestrevenue=\left(fairvalueofmachinery-leasereceivable\right)×rateofreturn \\ =\left(\$700,000-\$121,130\right)×10\% \\ =\$578,870×\frac{10}{100} \\ =\$57,887 \\ CalculationofInterestRevenueonDec.31,2018 \\ Interestrevenue=\left(fairvalueofmachinery-leasereceivable\right)×rateofreturn \\ =\left(\$700,000-\$121,130-\$63,243\right)×10\% \\ =\$515,627×\frac{10}{100} \\ =\$51,563 \end{gathered}$$

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