Question

On January 1, 2020, Better, Inc. entered into an equipment lease with Canyon Corp. under which Better agrees to lease equipment that was manufactured by Canyon and that has an expected useful life of 4 years. The cost to manufacture the equipment was $500,000 and its normal sales price is $600,000. The lease term is 3 years and Canyon expects to recover the equipment’s normal sales price through 3 lease payments in order to earn an 8% rate of return. The residual value is expected to be $53,000. Better doesn't guaranteed the residual value. The lease payment is due at lease signing date and each of the following December 31. Better is aware of Canyon’s expected rate of return and normally amortizes the assets by the straight-line method. Canyon is reasonably confident that Better will make the lease payments and has no material uncertainties.

Round your numbers to the nearest whole numbers.

Required:      

1. Calculate the annual lease payment.
2. According to the FASB, how should the lease be classified by both Better (lessee) and Canyon (lessor)? Why?
3. Calculate the present value of lease liability and lease receivable on lease signing date.

4. Prepare lease amortization schedules up to 12/31/2020 for both better and Canyon.

5. Prepare the journal entries to record the inception of the lease and the first lease payment on January 1, 2020 for both Better and Canyon.
6. Prepare the appropriate journal entries for both Better and Canyon at December 31, 2020.
7. Suppose at the end of the lease term, the actually residual value is $40,000 when the equipment is reverted back to lessor . State whether or not there will be any gain or loss occur to lessee and lessor.

Answer 1

Part 1 to 3

Year	PV factor @ 8%	Remarks
0	1.00000
1	0.92593	= 1 / 1.08
2	0.85734	= 0.92593 / 1.08
3	0.79383	= 0.85734 / 1.08
Total (0 to 2)	2.78326

Normal sales price	$        600,000
Less: Present value of unguaranteed residual value (0.79383*53000)	$          42,073
Amount recover through annual lease payments	$        557,927
Divided : Total Present Value Factor (as above)	2.78326
Annual lease payments	$        200,458

If you meet any criteria of below, then considered as a finance lease, otherwise considered as an operating lease.
Ownership criteria	is ownership transferred to the lessee at the end of lease period?	No
Specialized nature criteria	is leased asset have special nature and which is no alternative use to the lessor?	No
BPO criteria	is it reasonably certain to exercise of bargain purchase option?	No
Lease term criteria	is the lease period is equal to or more than 75% of the economic life of the leased asset? (3/4 = 75%)	Yes
Present value criteria	is the present value of payments equal to or more than 90% of the fair value of the leased asset? (557927/600000 = 92.99%)	Yes
	Type of Lease	Finance Lease

Finance lease is also known as capital lease.
Normal selling price is more than lessor's origional cost. This lease is considered for sales type lease with profit.
Lease be classified by
Better (lessee)	Capital lease
Canyon (lessor)	Sales-type lease (with profit)

Present value of lease liability (200458*2.78326)	$        557,927
Present value of lease receivable	$        600,000

Part 4 to 6

XUS 2020-09(2) SEP.xlsx - Microsoft Excel ? X FILE HOME INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW DEVELOPER Sign in R30 : y E F G H K L M N Р Q R S T 7 8 8 Better (lessee) Lease Amortization Schedule Canyon (lessor) Lease Amortization Schedule 9 9 10 Reduction Annual Lease Interest on of Lease Lease Payment Liability Liability Liability $ 557,927 $ 200,458 $ 0 $ 200,458 $ 357,469 $ 200,458 $ 28,598 $ 171,860 $ 185,609 $ 200,458 $ 14,849 $ 185,609 $ 0 Date Jan 1, 2020 Jan 1, 2020 Dec 31, 2020 Dec 31, 2021 11 Interest on Recovery Balance of Annual Lease Lease of Lease Lease Date Payment Receivable Receivable Receivable Jan 1, 2020 1 $ 600,000 Jan 1, 2020 1 $ 200,458 $ o $ 200,458 $ 399,542 Dec 31, 2020 $ 200,458 $ 31,963 $ 168,495 $ 231,047 Dec 31, 2021 $ 200,458 $ 18,484 $ 181,974 $ 49,073 Dec 31, 2022 $ 53,000 $ 3,927 $ 49,073 $ 0 Total 654,374 54,374 600,000 Last year's interest adjusted 12 13 / 1.08 14 / 1.08 15 Total 557,927 601,374 43,447 Last year's interest adjusted 16 17 18 19 Interest on Liability = Beginning Lease Liability * 8% Reduction of Lease Liability = Annual Lease Payment - Interest on Liability Lease Liability = Beginning Lease Liability - Reduction of Lease Liability Interest on Lease Receivable = Beginning Balance of Lease Receivable *8% Recovery of Lease Receivable = Annual Lease Payment - Interest on Lease Receivable Balance of Lease Receivable = Beginning Balance of Lease Receivable - Recovery of Lease Receivable 20 21 22 23 24 Credit Lease liability is also known as lease payable. Date Accounts titles and explanation Jan 1, 2020 Right of use Asset Lease liability (To record the lease) Debit 557,927 25 557,927 26 27 Present value of unguaranteed residual value ($42,073) is deducted from cost of goods sold and sales revenue. Date Accounts titles and explanation Debit Credit Jan 1, 2020 Lease receivable 600,000 Cost of goods sold (500000-42073) 457,927 Sales revenue (600000-42073) 557,927 Inventory of equipment 500,000 (To record lease agreement for sales type lease.) Activate Lindeks Jan 1. 2020 Cash 200.458 Sheet 70 + Go to Settings to activate Windows. Jan 1, 2020 200,458 28 29 30 31 200,458 Lease liability Cash (To record lease payment.) Sheet64 Sheet65 Sheet66 Sheet62 Sheet63 Sheet67 Sheet68 Sheet69 READY CALCULATE CIRCULAR REFERENCES 3 + + 100% 1 Search the web and Windows 0 ENG US 03:09 18-09-20

XIA 5 2020-09(2) SEP.xlsx - Microsoft Excel ? X FILE HOME INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW DEVELOPER Sign in R45 : X fx y E F L Р T 19 G H K Reduction of Lease Liability = Annual Lease Payment - Interest on Liability Lease Liability = Beginning Lease Liability - Reduction of Lease Liability M N R S Recovery of Lease Receivable = Annual Lease Payment - Interest on Lease Receivable Balance of Lease Receivable = Beginning Balance of Lease Receivable - Recovery of Lease Receivable 20 21 22 23 24 Credit Lease liability is also known as lease payable. Date Accounts titles and explanation Jan 1, 2020 Right of use Asset Lease liability (To record the lease) Debit 557,927 25 Present value of unguaranteed residual value ($42,073) is deducted from cost of goods sold and sales revenue. Date Accounts titles and explanation Debit Credit Jan 1, 2020 Lease receivable 600,000 Cost of goods sold (500000-42073) 457,927 Sales revenue (600000-42073) 557,927 Inventory of equipment 500,000 (To record lease agreement for sales type lease.) 26 557,927 27 28 29 Jan 1, 2020 Lease liability 200,458 30 Cash 200,458 31 (To record lease payment.) Jan 1, 2020 200,458 32 Cash Lease receivable (To record lease receipt.) 200,458 33 28,598 171,860 34 Dec 31, 2020 Interest expense Lease liability Cash (To record lease payment.) 35 200,458 200,458 36 Dec 31, 2020 Cash Interest revenue Lease receivable (To record lease receipt.) 31,963 168,495 37 38 39 Dec 31, 2020 Amortization Expense 185,976 Right of use Asset (To record amortization expense.) (557927/3) 185,976 40 41 42 Expected Residual value Actual Residual value loss occur to lessor $ 53,000 $ 40,000 $ 13,000 43 44 There is no gain or loss occur to lessee. Because of the lessee doesn't guaranteed the residual value. 45 Loss occur to the lessor = $13000 46 Activate Lindells Go to Settings to activate Windows. Sheet62 Sheet63 Sheet64 Sheet65 Sheet66 Sheet67 Sheet68 Sheet69 Sheet 70 + READY CALCULATE CIRCULAR REFERENCES 3 + + 100% 1 Search the web and Windows 0 ENG US 03:09 18-09-20

Part 7 last part

There is no gain or loss occur to lessee. Because of the lessee doesn't guaranteed the residual value.

	Expected Residual value		$      53,000
	Actual Residual value		$      40,000
	loss occur to lessor		$      13,000
Loss occur to the lessor = $13000