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Chapter 21: Q21-2E-b (page 1241)

Question: (Lessee Computations and Entries; Capital Lease with Guaranteed Residual Value) Pat Delaney Company leases an automobile with a fair value of \(8,725 from John Simon Motors, Inc., on the following terms:

  1. Noncancelable term of 50 months.
  2. Rental of \)200 per month (at end of each month). (The present value at 1% per month is \(7,840.)
  3. Estimated residual value after 50 months is \)1,180. (The present value at 1% per month is \(715.) Delaney Company guarantees the residual value of \)1,180.
  4. Estimated economic life of the automobile is 60 months.
  5. Delaney Company鈥檚 incremental borrowing rate is 12% a year (1% a month). Simon鈥檚 implicit rate is unknown.

Instructions

(b) What is the present value of the minimum lease payments?

Short Answer

Expert verified

Answer

The present value of the lease is $8,555.

Step by step solution

01

Meaning of Lease Payments

Lease payment is the monthly equivalent of rent formally determined under a contract between two parties, allowing one party to acquire the other's real estate holdings, construction equipment, computers, software, or other fixed assets for a specified period which confers a legal right to use.

02

Finding the present value of the minimum lease

In the case of residual value guaranteed by the lessee, the minimum lease payment includes the guaranteed residual value. Therefore the current value is:

Monthly payment of $200 for 50 months

$7,840

Residual value of $1,180

715

Present value of minimum lease payments

$8,555

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Most popular questions from this chapter

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

(3) Cost of sales.

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

  1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
  2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
  3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
  4. Cole Company assumes direct responsibility for all executory costs.
  5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
  6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(c) Prepare all of the journal entries for the lessor for 2017 and 2018 to record the lease agreement, the receipt of lease payments, and the recognition of income. Assume the lessor鈥檚 annual accounting period ends on December 31.

A lease agreement between Mooney Leasing Company and Rode Company is described in E21-8.

Inception date

May 1, 2017

Annual lease payment due at the beginning

of each year, beginning with May 1, 2017

\(21,227.65

Bargain-purchase option price at end of lease term

\) 4,000.00

Lease term

5 years

Economic life of leased equipment

10 years

Lessor鈥檚 cost

\(65,000.00

Fair value of asset at May 1, 2017

\)91,000.00

Lessor鈥檚 implicit rate

10%

Lessee鈥檚 incremental borrowing rate

10%

Instructions

(Round all numbers to the nearest cent.) Refer to the data in E21-8 and do the following for the lessor.

(c) Prepare the journal entries to reflect the signing of the lease agreement and to record the receipts and income related to this lease for the years 2017, 2018, and 2019. The lessor鈥檚 accounting period ends on December 31. Reversing entries are not used by Mooney.

On January 1, 2017, Irwin Animation sold a truck to Peete Finance for \(33,000 and immediately leased it back. The truck was carried on Irwin鈥檚 books at \)28,000. The term of the lease is 5 years, and title transfers to Irwin at lease-end. The lease requires five equal rental payments of $8,705 at the end of each year. The appropriate rate of interest is 10%, and the truck has a useful life of 5 years with no salvage value. Prepare Irwin鈥檚 2017 journal entries.

Metheny Corporation鈥檚 lease arrangements qualify as sales-type leases at the time of entering into the transactions. How should the corporation recognize revenues and costs in these situations?
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