Question

Lease exercises: 1, On June 30, year 1, Warner, Inc. leased a warehouse equipment from Lilly, Inc. The lease agreement calls for Warner to make semiannual lease payments of $546,915 over a four-year lease term (also the asset's useful life), payable each June 30 and December 31, with the first payment at June 30, year 1. Warner's incremental borrowing rate is 12%, the same rate Lilly used to calculate lease payment amounts. Lilly manufactured the equipment at a cost of $2.8 million. Required: 1. Prepare the appropriate entries for both (a) the lessee and (b) the lessor from the beginning of the lease through the end of year 1 2. prepare amortization table for two years 3. Explain what type of lease is for both, the lessee and the lessor. 2, On January 1, year 1, Mitchell-Marsh Services, Inc., a computer software training firm, leased several computers under a two-year operating lease agreement from Global Computers Corporation, which routinely finances equipment for other firms at an annual interest rate of 8%. The contract calls for four rent payments of $15,000 each, payable semiannually on June 30 and December 31 each year. The computers were acquired by Global Computers at a cost of $120,000 and were expected to have a useful life of six years with no residual value. Both firms record amortization and depreciation semiannually Required: Prepare the appropriate entries for both (a) the lessee and (b) the lessor through the end of year 1

Lease exercises: 1, On June 30, year 1, Warner, Inc. leased a warehouse equipment from Lilly, Inc. The lease agreement calls for Warner to make semiannual lease payments of $546,915 over a four-year lease term (also the asset's useful life), payable each June 30 and December 31, with the first payment at June 30, year 1. Warner's incremental borrowing rate is 12%, the same rate Lilly used to calculate lease payment amounts. Lilly manufactured the equipment at a cost of $2.8 million. Required: 1. Prepare the appropriate entries for both (a) the lessee and (b) the lessor from the beginning of the lease through the end of year 1 2. prepare amortization table for two years 3. Explain what type of lease is for both, the lessee and the lessor. 2, On January 1, year 1, Mitchell-Marsh Services, Inc., a computer software training firm, leased several computers under a two-year operating lease agreement from Global Computers Corporation, which routinely finances equipment for other firms at an annual interest rate of 8%. The contract calls for four rent payments of $15,000 each, payable semiannually on June 30 and December 31 each year. The computers were acquired by Global Computers at a cost of $120,000 and were expected to have a useful life of six years with no residual value. Both firms record amortization and depreciation semiannually Required: Prepare the appropriate entries for both (a) the lessee and (b) the lessor through the end of year 1

Add details, calculations and process.

Answer 1

First question

Lease payments	$546,915	at the beginning
Lease term	4 years or 8 periods	= Useful life
Incremental Borrowing rate	12%

The lease is said to be the finance lease if it satisfies of the many requirements, one being lease term is at least 75% of the estimated economic life of the asset.

In case of finance lease, the leased asset and liability shall be recognised at the lower of fair value or PV of MLP in the books of Lessee. The leased asset is depreciated over the tenure of lease.

PV of MLP = lease payment * AF(6%,8) =  $546,915 * 6.5824 = $3,600,000 (apprx)

Repayment Schedule
Year	Opening O/s	Interest	Principal	Closing O/s
1	$              3,600,000	$             -	$ 546,915	$ 3,053,085
2	$              3,053,085	$ 183,185	$ 363,730	$ 2,689,355
3	$              2,689,355	$ 161,361	$ 385,554	$ 2,303,801
4	$              2,303,801	$ 138,228	$ 408,687	$ 1,895,114
5	$              1,895,114	$ 113,707	$ 433,208	$ 1,461,906
6	$              1,461,906	$    87,714	$ 459,201	$ 1,002,706
7	$              1,002,706	$    60,162	$ 486,753	$    515,953
8	$                  515,953	$    30,957	$ 515,953	$                0

30-06-19	Warehousing Equipment	$ 3,600,000
	To Lease Liability		$ 3,600,000
	Recording the lease
30-06-19	Lease Liability	$    546,915
	To Bank		$    546,915
	Recording the first payment
31-12-19	Lease Liability	$    363,730
	Interest expense	$    183,185
	To Bank		$    546,915
	Recording the second payment
31-12-19	Depreciation (3.6/5 mill)	$    900,000
	To Warehousing Equipment		$    900,000
	Being Depreciation charged for the year
31-12-19	Profit & Loss	$ 1,083,185
	To Depreciation		$    900,000
	To Interest expense		$    183,185

In the books of Lessor,

Lease receivable at the inception of lease	= Net Investment in Lease
	= (PV of ALP + PV of GRV) +PV of URV
	=  $ 3,600,000+0+0 = $ 3,600,000

where Lease receivable ($3.6 millions) > carrying amount( $2.8 millions) of asset, it is classified as Sale type lease

30-06-19	Lease Receivable	$   3,600,000
	To Profit on lease		$          800,000
	To Warehouse Machine		$       2,800,000
30-06-19	Bank	$      546,915
	To Lease receivable		$          546,915
31-12-19	Bank	$      546,915
	To Finance Income		$          183,185
	To Lease receivable		$          363,730
31-12-19	Profit on lease	$      800,000
	Finance Income	$      183,185
	To Profit and loss		$          983,185

Second Question:

Operating Lease (given) with a 2 year term

In the books of lessor,

30-06-19	Bank	$      15,000
	To Lease rental income		$      15,000
30-06-19	Depreciation	$      10,000
	To Computers/accumulated dep		$      10,000
31-12-19	Bank	$      15,000
	To Lease rental income		$      15,000
31-12-19	Depreciation	$      10,000
	To Computers/accumulated dep		$      10,000
31-12-19	Lease rental income	$      30,000
	To Profit and Loss		$      30,000
31-12-19	Profit and Loss	$      20,000
	To depreciation		$      20,000

In the books of Lessee, as given in the question, even lessee would record amortisation semi annually.

Cost of debt	4%	Per period
Periods	1	2	3	4
Lease payments	$            15,000	$         15,000	$            15,000	$       15,000
PV of lease payments	$            14,423	$         13,868	$            13,335	$       12,822
Debt value of lease payments (PV total)	$            54,448	$         40,025	$            26,157	$       12,822
Amortisation expense (Debt/4:3:2:1)	$            13,612	$         13,342	$            13,079	$       12,822
Interest paid on lease payment(LR-Dep)	$               1,388	$           1,658	$              1,921	$         2,178

Timeout!