Question

Branif Leasing leases mechanical equipment to industrial consumers under sales-type leases that earn Branif a 20% rate of return for providing long-term financing. A lease agreement with Branson Construction specified 20 annual payments beginning December 31, 2018, the beginning of the lease. The estimated useful life of the leased equipment is 20 years with no residual value. Its cost to Branif was $672,003. The lease qualifies as a finance lease to Branson. Maintenance of the equipment was contracted for through a 20-year service agreement with Midway Service Company requiring 20 annual payments of $4,000 beginning December 31, 2018. Progressive insurance Company charges Branif $4,000 annually for hazard insurance coverage on the equipment. Both companies use straight-line depreciation or amortization. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
Prepare the appropriate entries for both the lessee and lessor to record the second lease payment and depreciation on December 31, 2019, under each of three independent assumptions:

1. The lessee pays maintenance costs as incurred. The lessor pays insurance premiums as incurred. The lease agreement requires annual payments of $115,000.
2. The contract specifies that the lessor pays maintenance costs as incurred. The lessee’s lease payments were increased to $119,000 to include an amount sufficient to reimburse these costs.
3. The lessee’s lease payments of $119,000 included $4,000 for hazard insurance on the equipment rather than maintenance.

Answer 1

In a finance lease transaction, risks and rewards inherent in the asset are transferred to the lessee.

Since a finance lease involves transfer of risk and rewards, the leased asset is recorded in the books of the lessee together with a corresponding lease liability. The leased asset is recorded at the present value of minimum lease payments (or fair value if it is lower). The present value of minimum lease payments is determined using the rate of interest implicit in the lease (or the lessee’s incremental rate of return if the interest rate implicit in the lease is not available).

Journal entries for both the lessee and lessor to record the second lease payment and depreciation on December 31, 2019 are as under: .

for 1st option:

for 2nd option:

IN THE BOOKS OF LESSOR			IN THE BOOKS OF LESSEE
Bank A/C Dr.	119,000		Branif A/C Dr.	119,000
To Branson Construction A/C		119,000	To bank A/c		119,000
maintenance Cost A/C Dr.	4000		there will be no entry in the book of lessee for maintenance cost
To Bank A/C		4000
There will be no changes in other entries

for 3rd option:

IN THE BOOKS OF LESSOR			IN THE BOOKS OF LESSEE
Bank A/C Dr.	119,000		Branif A/C Dr.	119,000
To Branson Construction A/C		119,000	To bank A/c		119,000
there will be no entry in the books of lessor for maintenance cost			maintenance Cost A/C Dr.	4000
			To Bank A/C		4000
There will be no changes in other entries