Question

On January 1, 2017, BMC Company leased equipment to Pioneer Tech Co. for a two-year period ending December 31, 2018. At the end of the lease term, the leased asset will be reverted back to BMC Company. The cost of the equipment is $27,000, and the fair value of the asset on 1/1/2017 is $43,141. The equipment has an expected useful life of three years on 1/1/2017. The lessee-guaranteed residual value at the end of the non-cancelable lease term is $6,000 with an expected residual value of $3,000. The annual lease payment is $20,000 and is due on January 1 of each year with the first payment on 1/1/2017. The collectiblility of the remaining lease payments is reasonably assured and the equipment does not possess a specialized nature.

      Both BMC Company and Pioneer Tech Co. use 10% discount rate and straight-line depreciation.

 

Required:

 

a. Show how BMC Company calculated the $20,000 annual lease payment.

 

b. How should this lease be classified by Pioneer Tech Co. (the lessee) and by BMC Company (the lessor)?

 

c. Prepare the appropriate entries for Pioneer Tech Co. on 1/1/2017, 12/31/2017, 1/1/2018 and 12/31/2018 (assuming that the equipment was reverted back to BMC and the residual value of the equipment on 12/31/2018 is $2,500 (Note: these entries should be prepared based on finance lease for Pioneer Tech regardless of your answer in b).

 

 

 

 

 

Answer 1

(a). BMC Company calculated the $20,000 annual lease payment:-

Step 1:-

The annual payment will be 'X' first

Date	Payments*	Pv factor @ 10%=	The present value of the payment
1/1/2017	X	1	X
1/1/2018	X	0.90909	0.90909X
31/12/2018	6,000	0.82645	4,958.7
Total			0.90909X+4,958.7

And the fair value is $43,141

Step 2:- Solving by equation:-

Annual lease payment = 1.90909X+4958.7 = $43,141

Annual lease payment = 1.90909x = $43,141-$4,958.7

Annual lease payment = X= $38,182.3/1.90909

Annual lease payment = $20,000

(b) The lease will be Finance Lease, the conditions apply:-

- The PV of the future lease payment is equal to the fair value

- The lease term is the part of useful life

(c). Journal entries:-

Date	Particulars	Debit	Credit
1/1/2017	Right of use asset	$43,141
	Lease liability		$43,141
1/1/2017	Lease liability	$20,000
	Cash		$20,000
12/31/2017	Interest expense	$2,314
	Interest payable		$2,314
	($43,141-$20,000= $23,141*10%
12/31/2017	Depreciation expense	$18,570.5
	Right of use asset		$18,570.5
	($43,141-$6,000)/2
1/1/2018	Lease liability	$17,686
	Interest payable	$2,314
	Cash		$20,000
12/31/2018	Right of use asset	$18,570.5
	Right of use asset		$18,570.5
12/31/2018	Loss on the reversal of lease asset	$3,500
	Right of use asset		$3,500
	($6,000-$2,500)

Answer 2

[REMOVED]