Question

At the beginning of 2021, VHF Industries acquired a machine with a fair value of $9,840,480 by signing a five-year lease. The lease is payable in five annual payments of $2.4 million at the end of each year. (FV of $1. PV of $1. FVA of $1. PVA of $1. FVAD of $1 and PVAD of S1 (Use appropriate factor(s) from the tables provided.) Required: 1. What is the effective rate of interest implicit in the agreement? 2-4. Prepare the lessee's journal entries at the beginning of the lease, the first lease payment at December 31, 2021 and the second lease payment at December 31, 2022. 5. Suppose the fair value of the machine and the lessor's implicit rate were unknown at the time of the lease, but that the lessee's incremental borrowing rate of interest for notes of similar risk was 6%. Prepare the lessee's entry at the beginning of the lease. Complete this question by entering your answers in the tabs below. Reg 1 Reg 2 and 4 Req 5 What is the effective rate of interest implicit in the agreement? The implicit interest rate 10% Req2 and 4 >

Answer 1

Requirement 1:

Implicit rate:

Present value of the lease payments = Fair value of the machine

Lease payments x present value annuity factor = Fair value of the machine

$2,400,000 x present value annuity factor = $9,840,480

Present value annuity factor = $9,840,480 ÷ $2,400,000

Present value annuity factor = 4.1002

Lease term is 5 years. So, we have to find out 4.1002 in the 'present value annuity table' in the Year 5 row.

It is matching at 7%.

Hence, Implicit rate is 7%.

Requirement 2-4:

Date	Account title and Explanation	Debit	Credit
January 01,2021	Right-of-use asset	$9,840,480
	Lease payable		$9,840,480
	[To record lease]
December 31,2021	Interest expense [9,840,480 x 7%]	$688,833.60
	Lease payable	$1,711,166
	Cash		$2,400,000
	[To record first lease payment]
December 31,2022	Interest expense [(9,840,480 - 1,711,166) x 7%]	$569,052
	Lease payable	$1,830,948.00
	Cash		$2,400,000
	[To record second lease payment]
December 31,2022	Interest expense [(9,840,480 - 1,711,166 - 1,830,948 ) x 7%]	$440,886
	Lease payable	$1,959,114.00
	Cash		$2,400,000
	[To record third lease payment]

Requirement 5:

Date	Account title and Explanation	Debit	Credit
January 01,2021	Right-of-use asset	$11,801,568*
	Lease payable		$11,801,568
	[To record lease]

*Present value of the lease payments = $2,400,000 x 4.91732 present value annuity factor (6%, 5 years) = $11,801,568