Question

Terms of a lease agreement and related facts were:

a. Incremental costs of commissions for brokering the lease and consummating the completed lease transaction incurred by the lessor were $6,652.
b. The retail cash selling price of the leased asset was $550,000.
c. Its useful life was three years with no residual value.
d. The lease term is three years and the lessor paid $550,000 to acquire the asset.
e. Annual lease payments at the beginning of each year were $200,000.
f. Lessor’s implicit rate when calculating annual rental payments was 9%.
(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:
1. Prepare the appropriate entries for the lessor to record the lease and related payments at its beginning, January 1, 2018.
2. Calculate the effective rate of interest revenue after adjusting the net investment by initial direct costs.
3. Record any entry(s) necessary at December 31, 2018, the fiscal year-end.

Answer 1

1) January 1, 2018, asset leased

Dr Lease receivable 550,000

Cr Equipment 550,000

January 1, incremental costs associated with lease transaction

Dr Lease receivable 6,652

Cr Cash 6,652

January 1, 2018, first lease payment collected

Dr Cash 200,000

Cr Lease receivable 200,000

2) to calculate the effective rate we can use the present value of an annuity due formula

PV annuity due factor, 3 periods, ?% = present value of lease receivable / annual payment = $556,652 / $200,000 = 2.78326

Now we must use an annuity due table to determine a possible rate. In this case, the exact rate is 8%.

3) December 31, 2018, interest receivable on lease contract

Dr Interest receivable 28,532

Cr Interest revenue 28,532

interest receivable = ($556,652 / $200,000) x 8% = $28,532