Question

Universal Leasing leases electronic equipment to a variety of businesses. The company’s primary service is providing alternate financing by acquiring equipment and leasing it to customers under long-term sales-type leases. Universal earns interest under these arrangements at a 8% annual rate.
  
The company leased an electronic typesetting machine it purchased for $38,000 to a local publisher, Desktop Inc. on December 31, 2017. The lease contract specified annual payments of $8,348 beginning January 1, 2018, the beginning of the lease, and each December 31 through 2019 (three-year lease term). The publisher had the option to purchase the machine on December 30, 2020, the end of the lease term, for $18,600 when it was expected to have a residual value of $22,600, a sufficient difference that exercise seems reasonably certain. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Show how Universal calculated the $8,348 annual lease payments for this sales-type lease.
2. Prepare an amortization schedule that describes the pattern of interest revenue for Universal Leasing over the lease term.
3. Prepare the appropriate entries for Universal Leasing from the beginning of the lease through the end of the lease term.

Answer 1

(1) -- Show how Universal calculated the $8348 annual lease payments for this sales-type lease.

Answer -

	Particulars	Explanation
I.	Amount to be recovered (fair value)	Given in question	$38000
II.	Present value of the bargain purchase option price	= $18600 * PVIF of $1 (i%, n) = $18600 * $1 (8%,3) = $18600 * 0.79383 = $14765	$14765
III.	Amount to be recovered through periodic lease payments	I - II	$23235
IV.	Present value of an annuity due of $1 (8%,3)	Refer PVAD Table	2.78326
Annual lease payments		III / IV	$8348

.

(2) -- Prepare an amortization schedule that describes the pattern of interest revenue for Universal Leasing over the lease term.

Answer -

Lease Amortization Schedule

Date	Payments ($)	Effective Interest ($)	Decrease in Balance ($)	Outstanding Balance ($)
1/1/2018	-	-	-	38000 [Given in question]
1/1/2018	8348 [Given in question]	-	8348	29652 [38000 - 8348]
12/31/2018	8348 [Given in question]	2372 [29652 * 8%]	5976 [8348 - 2372]	23676 [29652 - 5976]
12/31/2019	8348 [Given in question]	1894 [23676 * 8%]	6454 [8348 - 1894]	17222 [23676 - 6454]
12/31/2020	18600 [Given in question]	1378 [17222 * 8%]	17222 [18600 - 1378]	0 [17222 - 17222]

.

(3) -- Prepare the appropriate entries for Universal Leasing from the beginning of the lease through the end of the lease term.

Answer -

Date	General Journal	Debit ($)	Credit ($)
1/1/2018	Lease receivable Machinery [Given in question]	38000 -	- 38000
1/1/2018	Cash [Given in question] Lease receivable	8348 -	- 8348
12/31/2018	Cash [Given in question] Interest revenue [$29652 * 8%] Lease receivable [Difference]	8348 - -	- 2372 5976
12/31/2019	Cash [Given in question] Interest revenue [$23676 * 8%] Lease receivable [Difference]	8348 - -	- 1894 6454
12/31/2020	Cash [Given in question] Interest revenue [$17222 * 8%] Lease receivable [Difference]	18600 - -	- 1378 17222