Question

On January 1, 2020, Tiffany Company leased new equipment to Masy’s Corporation. The equipment cost Tiffany $180,000. The lease agreement specified that Masy’s is to make five annual lease payments (on January 1, beginning January 1, 2020) to yield Tiffany a 5% return. The equipment has a five-year useful life with an unguaranteed residual value of $9,000. In December 2019, Tiffany paid Masy’s $1,000 as an incentive to sign the lease and Masy’s paid legal fees of $500 related to the execution of the lease. Ownership of the lease asset remains with Tiffany at the end of the lease term. Masy’s is aware of the implicit interest rate used by Tiffany. The accounting period for Masy’s ends December 31.

Required:

a. Compute the annual fixed lease payment.

b. What type of lease is this to the lessee? Explain.

c. Provide all journal entries associated with this lease for the lessee for the years ended December 31, 2020, and 2021.

Answer 1

Requirement 1: Lease payments to be made at the beginning of the year. Cost to be recovered by lessor Fair value of the leased equipment 180,000 Add Incentive paid to Marsh [lessee Less: Present value of unguranteed residual vale 1000 181,000 -7052 9,000 x PVF 5 years, 5%] = 9,000 x 0.78353 Amount to be recovered by lessor through lease payments 173,948 Five beginning of year lease payments to earn a 5%return 38264.39 [$173,948 PVF - AD 5,5% ] = $173,948 / 4.54595 Requirement 2: It is a capital due to the following reasons 1. lease period [5 years] covers entire life of the equipment. 2. Majority of the cost is recovered in the lease period. 3. Legal costs are borne by lessee.

Requirement 3 Lease amortization schedule [ lessee - marsh] Reduction of Interest @5% lease liability Annual lease payment Lease liability date liability on $173,948.00 1-Jan-20 1-Jan-20 $ 38,264.39 $ 135,683.61 31,480.21 $ 104,203.40 33,054.22 $ 38,264.39 6,784.18 $ 5,210.17 $ 38,264.39 $ 38,264.39 $ 1-Jan-21 $ 1-Jan-22 $ 71,149.18 Journal entries in the books of date Accounts title & explantion Debit Credit $ 1-Jan-20 Leased equipment under capital lease 173,498.00 $173,498.00 Lease liability [To record lease 1-Jan-20 Lease liability 38,264.39 $ Cash 38,264.39 31-Dec-20 Interest payable 6,784.18 Interest expense 6,784.18 [To record accrued interest 1-Jan-21 Interest expense 6,784.18 Lease liability 38,264.39 cash 45,048.57

1-Jan-21 Interest expense $ 6,784.18 Lease liability $ 38,264.39 cash 45,048.57 31-Dec-21 Interest payable 5,210.17 Interest expense 5,210.17 [To record accrued interest