Question

Cullumber Company is evaluating a lease arrangement being offered by TSP Company for use of a computer system. The lease is noncancelable, and in no case does Cullumber receive title to the computers during or at the end of the lease term. The lease starts on January 1, 2017, with the first rental payment due on January 1, 2017. Additional information related to the lease is as follows.

Yearly rental		$3,710.00
Lease term		3 years
Estimated economic life		5 years
Purchase option		$3,000 at end of 3 years, which approximates fair value
Renewal option		1 year at $1,500; no penalty for nonrenewal; standard renewal clause
Fair value at inception of lease		$10,200
Cost of asset to lessor		$10,200
Residual value:
Guaranteed		–0–
Unguaranteed		$3,000
Lessor’s implicit rate (known by the lessee)		11%
Executory costs paid by:		Lessor; estimated to be $560 per year (included in rental equipment)
Estimated fair value at end of lease		$3,000

(a) Analyze the lease capitalization criteria for this lease for Cullumber Company. Prepare the journal entry for Cullumber on January 1, 2017. (Credit account titles are automatically indented when the amount is entered. Do not indent manually. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answers to 2 decimal places, e.g. 52.75. If no entry is required, select "No entry" for the account titles and enter 0 for the amounts.)

Click here to view factor tables

Date	Account Titles and Explanation	Debit	Credit
Jan. 1

Answer 1

Answer with explanation is given below

A Lease is a Finance Lease if any of the following conditions is fulfilled a) - The asset must be transferred to the lessee at the end of the term b) - The lessee has an option to purchase the asset at the end of the term below its fair value c) - The lease term covers the significant period of the asset's useful life (at least 75% or more) e) - The present value of future lease payments covers the substantial part of asset cost ( at least 90%) f) -The leased asserts is of specialised nature and suits the needs of lessee only a) The lease does not transfer title at the end of the term. Hence criteria is not met b) Purchase is at fair value at end of the term and not below it. Hence criteria is not met c) Lease term is 3 years Economic life of asset is 5 years So it is 60% of total life of asset. Hence criteria is not met d) Calculation of present value of lease payments Minimum lease payments Rental payments-executory costs ($3,710-$560) $3,150.00 PV of Lease PV factor Lease Year Amount at 11% $3,150 payments $8,544 2.7125 0 $10,200 84% Fair value at the inception of the lease PV of lease payment as % of lease payments Since the PV of lease payment is 849% criteria is not met e) Asset is not of specialized nature. Hence criteria is not met Therefore the lease is accounted as operating Lease

Account Titles and Explanation Debit Credit Date Jan-01 Rent Expense $3,710 $3,710 To Cash (Being payment of lease rental)