Homework Answers
(a) The lease will be classified as a financial lease.
Explanation: A lease is classified as a financial lease if it satisfies at least one of the following conditions:
- the asset is leased for the major part of its remaining economic life (75% of the estimated useful life),
- ownership rights is transferred at the end of the lease term,
- the lessee has the option to purchase the asset after expiry of the lease term,
- the asset is of specialized nature that it is not expected to have alternative use after lease term without substantial changes,
- the present value of lease payments and guaranteed residual value exceeds fair value of the asset substantially (90% of equipment cost)
In the above case, the life of the asset is 4 years and the lease term is 3 years i.e. the asset is leased for major part of its economic life. Hence, the lease will be classified as financial lease.
(b)
PV of lease rentals = Annual lease rentals * PV for ordinary annuity for 3 years @ 10%
= $20,000 * 2.48685
= $49,737
Journal Entry in the books of lessor on January 1, 2019
Dr. Lease receivable $49,737
Cr. Asset $49,737
Journal Entry in the books of lessee on January 1, 2019
Dr. Leased Asset $49,737
Cr. Lease Liability $49,737
(c)
Journal Entry in the books of lessor on December 31, 2019
Dr. Cash $20,000
Cr. Lease Receivable ($20,000 - $4,973) $15,027
Cr. Finance Income (10% of $49,737) $4,973
Journal Entry in the books of lessee on December 31, 2019
Dr. Lease liability $15,027
Dr. Interest Expense $4,973
Cr. Cash $20,000
(Note: In financial lease, the lessee will also post an additional entry to recognize the depreciation expense as if it is an owned asset)
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