Question

PROBLEMS 8 P21-1 (Lessee- Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease ma Jensen Corporation on January 1, 2014. The following information relates to the lease agreement. 1. The term of the lease is 7 years with no renenval option, and the machinery has an estimated eco 2. The cost of the machinery is $525,000, and the fair value of the asset on January 1, 2014, is $700,000 of nomic life of 9 years. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value $100,000 Jensen depreciates all of its equipment on a straight-line basis. d. The lease agreement requires equal annual rental payments, beginning on January 1, 2014 tainties surrounding the amount of costs yet to be incurred by the lessor. nil hels ate of return on is investments Jensen's incremental borrowing rate is 11 5. The collectibility of the lease payments is reasonably predictable, and there are no important un t uncer borrowing rate is 11%, and the lessor's implicit rate is unknown. Instructions Assume the accounting period ends on December 31.) (a) Discuss the nature of this lease for both the lessee and the lessor. (b) Calculate the amount of the annual rental payment required.

Answer 1

	Lessee:-
A	This is a Capital lease to Jensen (Lessee) since the lease term is greater than 75% of the economic life of the leased asset. The lease term is 78% (7÷9) of the asset’s economic life.
	Lessor:-
	This is a Capital lease to Glaus (Lessor) because collectability of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is greater than 75% of the asset’s economic life. Since the fair value ($700,000) of the equipment exceeds the lessor’s cost ($525,000), the lease is a Sales-type lease.

B	Calculation of Annual Rental Payment:
	Present value of $1 at 10% for 7 periods is 0.51316
	Present value of an annuity due at 10% for 7 periods is 5.35526
=	{$700,000-($100,000x0.51316)}/5.35526
=	{$700,000- $51,316}/5.35526
=	$648,684/5.35526
=	$121,130
	Annual Rental Payment required is $121,130

C	Computation of present value of minimum lease payments
	Present value of an annuity due at 11% for 7 periods is 5.23054
	Present value of $1 at 11% for 7 periods is 0.48166
	PV of Annual payments:$121,130 X 5.23054	$        633,575
	PV of guaranteed residual value:$100,000 X 0.48166	$          48,166
	Present value of minimum lease payments	$        681,741

D		Journal Entries In the books of Jesen (Lessee)
	Date	Account Titles and Explanations	Debit $	Credit $
	1/1/2014	Leased Equipment	681,741
		Lease Liability		681,741
		(To record Leased Equipment)
	1/1/2014	Lease Liability	121,130
		Cash		121,130
		(To record Lease Payment)
	12/31/2014	Depreciation Expenses	83,106
		Accumulated Depreciation- Capital Lease		83,106
		($681,741-$100,000)/7 years=$83,106
		(To record Depreciation Expenses)
	12/31/2014	Interest Expense	61,667
		Interest Payable		61,667
		($681,741 – $121,130) X .11
		(To record Interest Expenses)
	1/1/2015	Lease Liability	59,463
		Interest Payable	61,667
		Cash		121,130
		(To record Lease Payment)
	12/31/2015	Depreciation Expenses	83,106
		Accumulated Depreciation- Capital Lease		83,106
		($681,741-$100,000)/7 years=$83,106
		(To record Depreciation Expenses)
	12/31/2015	Interest Expense	55,126
		Interest Payable		55,126
		($681,741 - $121,130 - $59,463) X .11
		(To record Interest Expenses)

E		Journal Entries In the books of Glaus (Lessor)
	Date	Account Titles and Explanations	Debit $	Credit $
	1/1/2014	Lease Receivable	700,000
		Cost of Goods Sold	525,000
		Sales Revenue		700,000
		Inventory		525,000
		(To record Sale of Leased Equipment)
	1/1/2014	Cash	121,130
		Lease Receivable		121,130
		(To record receipt of Lease Payment)
	12/31/2014	Interest Receivable	57,887
		Interest Revenue		57,887
		[($700,000 – $121,130) X .10]
		(To record Interest Revenue)
	1/1/2015	Cash	121,130
		Lease Receivable		63,243
		Interest Receivable		57,887
		(To record receipt of Lease Payment)
	12/31/2015	Interest Receivable	51,563
		Interest Revenue		51,563
		[($700,000 – $121,130 -$63,243) X .10]
		(To record Interest Revenue)