Question

The following facts pertain to a non-cancelable lease agreement between Ford and NextCar, a lessee.

                Lease Origination Date                                                                                                                   May 1, 2017

                Annual lease payments due at the beginning of each lease year                                   $20.471.94

                Bargain purchase option price at the end of lease term                                                   $4,000

                Lease term                                                                                                                                          5 years

                Economic life of leased equipment                                                                                          10 years

                Lessor’s cost                                                                                                                                       $65,000

                Fair value of asset on May 1, 2017                                                                                             $91,000

                Fair value of asset on May 1, 2022                                                                                             $15,000

                Lessor implicit rate                                                                                                                          8%

                Lessee’s incremental borrowing rate                                                                                       8%

The collectability of the lease payments is probable.

1. What type of lease is this and why?.Prepare the journal entries on the lessee’s book to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. NextCar has an April 30^th year end.

Answer 1

Answer:

Criteria to identify the type of lease:

(i) There is bargain purchase option available to the lessee.

(ii) The life of the lease is 5 years and the economic life of the asset is 10 years. This is only 50% and is less than 75%

(iii) Total PV = PV of minimum lease payment + PV of unguaranteed residual value

     = $20,471.94 × 4.31212 + $4,000 × 0.68058

    = $88,278 + $2,722 = $91,000

      Asset's fair value is $91,000

      % of total PV to asset's fair value = $91,000/$91,000 × 100 = 100% which is higher than 90%

Conclusion: This is a financing/capital lease because criteria (i) and (iii) is met and during the lease, the risks and rewards of the asset have been fully transferred.

Accounts Credit (in $) Journal in the book of lessee Date May.01, 2017 Leased equipment Lease payable Debit (in $) $91,000.00 $91,000.00 May 01, 2018 Lease payable Interest expense Cash 14,829.70 5,642.24 20,471.94

(2) Year (1) May.01, 2017 $ May.01, 2018 $ May.01, 2019 $ May.01, 2020 $ May.01, 2021 $ May 01, 2022 $ LEASE AMORTIZATION SCHEDULE Opg Bal. Lease Rent Interest Exp Reduction in O/s Liabl Closing Bal. (3) (4) = (2) x 8% (5) = (3) - (4) (6) = (2) - (5) 91,000.00 $ 20,471.94 $ 20,471.94 $ 70,528.06 70,528.06 $ 20,471.94 $ 5,642.24 $ 14,829.70 $ 55,698.36 55,698.36 $ 20,471.94 $ 4,455.87 $ 16,016.07 $ 39,682.29 39,682.29 $ 20,471.94 $ 3,174.58 $ 17,297.36 $ 22,384.94 22,384.94 $ 20,471.94 $ 1,790.80 $ 18,681.14 $ 3,703.79 3,703.79 4,000 $ 296.21 $ 3,703.79 $ 0.00