Question

Mid-South Auto Leasing leases vehicles to consumers. The attraction to customers is that the company can offer competitive prices due to volume buying and requires an interest rate implicit in the lease that is one percent below alternate methods of financing. On September 30, 2018, the company leased a delivery truck to a local florist, Anything Grows.

The lease agreement specified quarterly payments of $5,000 beginning September 30, 2018, the beginning of the lease, and each quarter (December 31, March 31, and June 30) through June 30, 2021 (three-year lease term). The florist had the option to purchase the truck on September 29, 2020, for $10,000 when it was expected to have a residual value of $17,500. The estimated useful life of the truck is four years. Mid-South Auto Leasing’s quarterly interest rate for determining payments was 2% (approximately 8% annually). Mid-South paid $40,000 for the truck. Both companies use straight-line depreciation or amortization. Anything Grows’ incremental interest rate is 8%.

Hint: A lease term ends for accounting purposes when an option becomes exercisable if it’s expected to be exercised (i.e., a BPO). (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. Calculate the amount of selling profit that Mid-South would recognize in this sales-type lease. (Be careful to note that, although payments occur on the last calendar day of each quarter, since the first payment was at the beginning of the lease, payments represent an annuity due.)
2. Prepare the appropriate entries for Anything Grows and Mid-South on September 30, 2018.
3. Prepare an amortization schedule(s) describing the pattern of interest expense for Anything Grows and interest revenue for Mid-South Auto Leasing over the lease term.
4. Prepare the appropriate entries for Anything Grows and Mid-South Auto Leasing on December 31, 2018.
5. Prepare the appropriate entries for Anything Grows and Mid-South on September 29, 2020, assuming the purchase option was exercised on that date.

Answer 1

Quarterly Rate of Interest = 12%/4	2.00%
Period	8	quarters
1)
Present value of Quaterly lease payments = $4000 x PVAD(2%,8) = $5000 x 7.4720	$  37,360.00
Add: Present value of the BPO price ($10,000 x PV(2% ,8) = $10000 x .8535	$    8,535.00
Present value of minimum lease payments	$  45,895.00
Less:  Selling Cost of Truck	$ (40,000.00)
Dealer's Profit	$    5,895.00
2)
Journal Entries for Anythings Grow on Sept.30 2018	Debit	Credit
Leased Equipment	45895
LeasePayable (Present value of minimum lease payments)		45895
Lease Payable	5000
Cash (Quarterly lease Payment)		5000
Journal entries for Mid-south
Lease Receivables	45895
Cost of Good Sold (lessor's cost)	40000
Sales Revenue		45895
Equipment		40000
Cash	5000
Lease Receivables		5000
3)
Lease Amortization Schedule
The amortisation schedule for Lessor and Lesse will be same as they are using same discount rate
Period	Payment	Interest = 2% x Outstanding Balance	Decrease in Balance	Outstanding Balance
Sep 30 2018				$45,895.00
Sep 30 2018	$    5,000.00		$  5,000.00	$40,895.00
Dec 31 2018	$    5,000.00	$     817.90	$  4,182.10	$36,712.90
Mar 31 2019	$    5,000.00	$     734.26	$  4,265.74	$32,447.16
June 30 2019	$    5,000.00	$     648.94	$  4,351.06	$28,096.10
Sep 30 2019	$    5,000.00	$     561.92	$  4,438.08	$23,658.02
Dec 31 2019	$    5,000.00	$     473.16	$  4,526.84	$19,131.18
Mar 31 2020	$    5,000.00	$     382.62	$  4,617.38	$14,513.81
June 30 2020	$    5,000.00	$     290.28	$  4,709.72	$  9,804.08
Sep 30 2020	$  10,000.00	$     195.91	$  9,804.09	$        (0.00)
	$  50,000.00	$  4,105.00	$45,895.00
4)
31-Dec-18
Anything Grows (Lessee)
Depreciation expense ([$45,895 ÷ 4 years*] x 1/4 year)	$    2,868.44
Accumulated depreciation		$  2,868.44
Interest expense (2% x [$45,895 – 5,000]	$       817.90
Lease payable (difference)	$    4,182.10
Cash (lease payment)		$  5,000.00
Mid-South Auto Leasing (Lessor)
Cash (lease payment)	$    5,000.00
Lease receivable (difference )		$  4,182.10
Interest revenue (2% x [$45,895 – 5,000]		$     817.90
5)
Anything Grows (Lessee)
Depreciation expense ([$45,895 ÷ 4 years*] x 3/4 year)	$    8,605.31
Accumulated depreciation		$  8,605.31
Interest expense (2% x $9804)	$       195.91
Lease payable (difference: from schedule)	$    9,804.09
Cash (BPO price)		10000
Mid-South Auto Leasing (Lessor)
Cash (BPO price)	10000
Lease receivable (difference)		$  9,804.09
Interest revenue ( (2% x $9804)		$     195.91