Question

On January 1, 2020, Pharoah Company leased equipment to Flynn Corporation. The following information pertains to this lease.

1. The term of the non-cancelable lease is 6 years. At the end of the lease term, Flynn has the option to purchase the equipment for $1,000, while the expected residual value at the end of the lease is $9,000.

2. Equal rental payments are due on January 1 of each year, beginning in 2020.

3. The fair value of the equipment on January 1, 2020, is $120,000, and its cost is $110,000.

4. The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.

5. Pharoah set the annual rental to ensure a 6% rate of return. Flynn’s incremental borrowing rate is 8%, and the implicit rate of the lessor is unknown.

6. Collectibility of lease payments by the lessor is probable.

Both the lessor and the lessee’s accounting periods end on December 31.

-Calculate the amount of the annual rental payment.

Answer 1

Answer : calculation of amount of annual rental payment :

Particularls	Amount
Fair value if equipment	$1,20,000
Less : present value of residual value at the end of lease ($9,000 × Pvf (6%, 6) ($9,000 × 0.7047) ($6,342.3)	($6,342.3)
Present value of annual payments	$1,13,657.7
payments at beginning of the year & present value of annuity factor for 6 years @6% i.e., PVAF (6%, 6) , (1 + 4.9173 )	5.9173
Annual Rental payment ($1,13,656.7 ÷ 5.9173)	$19,207.52