Question

Kaluzniak Corporation leased equipment to Moeller, Inc. on January 1, 2020. The lease agreement called for annual rental payments of $1,137 at the beginning of each year of the 3-year lease. The equipment has an economic useful life of 7 years, a fair value of $7,000, a book value of $5,000, and Kaluzniak expects a residual value of $4,500 at the end of the lease term. Kaluzniak set the lease payments with the intent of earning a 6% return, though Moeller is unaware of the rate implicit in the lease and has an incremental borrowing rate of 8%. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

Required:
a. Explain (and show calculations) how Kaluzniak arrived at the amound of the rental payments used in the lease agreement.
b. Prepare the entries for Kaluzniak for 2017.
c. How would Kaluzniak's accounting in part (a) change if it incurred legal fees of $700 to execute the lease documents and $500 in advertising expenses for the year in connection with the lease?

Answer 1

a). Fair value of the leased asset $ 7000

Less:
`\text{Present value}` of unguaranteed residual $ 3778.29

value [4500 x PV(6,3%)]

Amount to be recovered through lease payment $ 3221.71

Three periodic lease payment $ 1137.05

Rental payments $ 1137.00

b). Journal entries in the books of Kaluzniak.

Date Particulars Debit($) Credit($)

2020 Jan 1 Cash account 1137

To unearned lease revenue 1137

Jan 1 Unearned lease revenue 1137

To lease revenue 1137

Dec 31 Depreciation expense 714.29

To accumulated depreciation equipment 714.29

c).

Date Particulars Debit($) Credit($)

Jan 1, 2020 Legal fee 700

To cash 700

Jan 1 Advertisement 500

To cash 500