Question

Problem 15-2 Finance lease [LO15-2 At the beginning of 2018, VHF Industries acquired a machine with a fair value of $8,099,300 by signing a four-year lease. The lease is payable in four annual payments of $2.5 million at the end of each year.(EV of S1. PV of $1. EVA of S1. PVA of S1, EVAD ot 51 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required 1. What is the effective rate of interest implicit in the agreement? 2-4. Prepare the lessee's journal entries at the beginning of the lease, the first lease payment at December 31, 2018 and the second lease payment at December 31, 2019. 5. Suppose the fair value of the machine and the lessor's implicit rate were unknown at the time of the lease, but that the lessee's incremental borrowing rate of interest for notes of similar risk was 8%. Prepare the lessee's entry at the beginning of the lease. Complete this question by entering your answers in the tabs below. Req 1 Req 2 and 4 Req 5 What is the effective rate of interest implicit in the agreement? The implicit interest rat > Req 2 and 4

Answer 1

Solution 1:

Let effective interest rate implicit in lease = i

Now at i present value of lease payment = Fair value of machine

Cumulative PV Factor at i for 4 periods = $8,099,300 / $2,500,000 = 3.23972

Refer PV factor table, this factor falls at i = 9%

Therefore implicit interest rate in lease = 9%

Solution 2-4:

Journal Entries - VHF Industries
Date	Particulars	Debit	Credit
1-Jan-18	Machinery Dr	$8,099,300.00
	To Lease Payable		$8,099,300.00
	(To record machiney purchased on lease)
31-Dec-18	Interest expense Dr ($8,099,300*9%)	$728,937.00
	Lease Payable Dr	$1,771,063.00
	To Cash		$2,500,000.00
	(To record lease payment)
31-Dec-19	Interest expense Dr [($8,099,300 - $1,771,063)*9%]	$569,541.00
	Lease Payable Dr	$1,930,459.00
	To Cash		$2,500,000.00
	(To record lease payment)

Solution 5:

Fair value of machine = $2,500,000 * Cumulative PV Factor at 8% for 4 periods

= $2,500,000 * 3.312127 = $8,280,317

Journal Entries - VHF Industries
Date	Particulars	Debit	Credit
1-Jan-18	Machinery Dr	$8,280,317.00
	To Lease Payable		$8,280,317.00
	(To record machiney purchased on lease)