Question

Logan Inc. manufactures a machine with an estimated life of 12 years and leases it to Quad Center for a period of 10 years. The normal selling price of the machine is $495,678 and its guaranteed residual value at the end of the non-cancelable leas term is estimated to be $15,000. The Quad Center will pay rents of $60,000 at the beginning of each year. Logan incurred costs of $300,000 in manufacturing the machine. Logan has determined that the collectability of the lease payments is probable and that the implicit interest is 5%. Assume Quad Center has an incremental borrowing rate of 5% and expects the value of the machine to be $10,000 at the end of the lease.

Required:

1. Prepare the journal entries for Quad Center for the first two years of the lease agreement
2. Prepare the journal entries for Logan for the first two years of the lease agreement

Answer 1

Journal Entries in the books of the Quad Centre:-

a) Calculation of PV of MLPS

Year	Lease Rents	PV @ 5%	PV of Cash Flows
1	60000	.9524	57144
2	60000	.9070	54420
3	60000	.8638	51828
4	60000	.8227	49362
5	60000	.7835	47010
6	60000	.7462	44772
7	60000	.7107	42642
8	60000	.6768	40608
9	60000	.6446	38676
10	75000	.6139	46043
		Total	472505

In Financial Lease asset should be recognised at the lower of

a) FV of the asset (or)

b) PV of MLPS

Hence Asset should be recognised at $472505

Journal Entries for the first Year:-

At the Inception of the Lease

1.Finaincial Lease Asset A/c Dr $472505

to Lease Liability $472505

2.Lease Liability A/c Dr $60000

to Bank $60000

At the End of the Year:

1.Interest Expenses($472505-$60000)*5% $20625

to Lease Liability $20625

2.Depreciation A/c Dr $47251

to Financial Lease Asset $47251.

3.Profit & Loss A/c Dr $67876

to Interest Expenses $20625

to Depreciation $47251.

For the Year 2:-

1.Lease Liability A/c Dr $60000

to Bank $60000.

2.Interest Expenses A/c Dr (373130*5%) $18657

to Lease Liablity $18657.

3.Depreciation A/c Dr $47251

to Financial Asset Lease $47251.

4.Profit & Loss A/c Dr $65908

to Interest Expenses $18657

to Depreciation $ 47251.

Journal Entries in the books of the Logan:-

At the Inception of the Lease.

1.Lease Receivable A/c Dr $472505

to Financial Lease Asset $472505.

2.Bank A/c Dr $60000

to Lease Receivable $60000

At the End of the Year 1.

1.Lease Receivable A/c Dr $20625

to Interest Income $20625

2.interest income A/c Dr $20625

to Profit & Loss A/c $20625.

For the Year 2:-

1.Bank A/c Dr $60000

to Lease Receivable $60000

2.Lease Receivable A/c Dr $18657

to Interest income $18657

3.Interest Income A/c Dr $18657

to Profit & loss A/c $18657.