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# Leases

## Practice as You Learn

Problem 1 – Finance / Sales-Type Lease without a Sales Profit and No Residual Value

Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset is \$40,000 (also the asset’s fair value on the lease date). The lease term is 4 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The asset has no residual value. The effective rate of the lease is 8%.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.

80% of the life is substantially all of the useful life of the asset
The PV of the minimum lease payments is 100% of the fair value of the asset

A. Calculate the lease payment:

 Cost or FMV of asset 40,000 – Present value of RV or BPO 0 = Payments cover 40,000 / PV factor of annuity due 3.5771 = Annual Payment 11,182

B. Amortization Schedule:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$11,182 \$11,182 \$28,818 12/31/X1 \$11,182 \$2,305 \$ 8,877 \$19,941 12/31/X2 \$11,182 \$1,595 \$ 9,587 \$10,355 12/31/X3 \$11,182 \$   827 \$10,355 \$         0

C. Journal entries 1st Year

 Lessor Lessee Lease Receivable        \$40,000 Right of Use Asset         \$40,000 Asset                                \$40,000 Lease Payable                 \$40,000 Cash                              \$11,182 Lease Payable                \$11,182 Lease Receivable            \$11,182 Cash                                \$11,182 Cash                              \$11,182 Interest Expense           \$2,305 Lease Receivable         \$8,877 Lease Payable              \$8,877 Interest Revenue          \$2,305 Cash                                \$11,182 Amortization Expense   \$10,000 Right to Use Asset         \$10,000

Problem 2 – Finance / Sales-Type Lease with Sales Profit and No Residual Value

Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset is \$30,000 and the asset’s fair value on the lease date is \$40,000. The lease term is 4 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The asset has no residual value. The effective rate of the lease is 8%.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.

\$40,000 lessee’s cost (FMV)
– \$30,000 lessor’s cost
= \$10,000 profit

80% of the life is substantially all of the useful life of the asset
The PV of the minimum lease payments is 100% of the fair value of the asset

A. Calculate the lease payment:

 Cost or FMV of asset 40,000 – Present value of RV or BPO 0 = Payments cover 40,000 / PV factor of annuity due 3.5771 = Annual Payment 11,182

B. Amortization Schedule:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$11,182 \$11,182 \$28,818 12/31/X1 \$11,182 \$2,305 \$ 8,877 \$19,941 12/31/X2 \$11,182 \$1,595 \$ 9,587 \$10,355 12/31/X3 \$11,182 \$   827 \$10,355 \$         0

C. Journal entries 1st Year

 Lessor Lessee 1/1/20X1: Lease Receivable        \$40,000 Right of Use Asset         \$40,000 Asset                                \$40,000 Lease Payable                 \$40,000 Cost of Goods Sold      \$30,000 Asset                          \$30,000 Cash                              \$11,182 Lease Payable                \$11,182 Lease Receivable            \$11,182 Cash                                \$11,182 12/31/20X1: Cash                              \$11,182 Interest Expense           \$2,305 Lease Receivable          \$8,877 Lease Payable              \$8,877 Interest Revenue           \$2,305 Cash                                \$11,182 Amortization Expense   \$10,000 Right to Use Asset         \$10,000

Problem 3. Finance / Sales-Type Lease without Sales Profit with Guaranteed Residual Value

Same lease as problem 1, and the lease has a \$2,000 guaranteed residual value.
At the end of the lease the actual fair market value of the asset is \$1,500.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease
D. Record the return of the asset at the end of the lease.

A. Calculate the lease payment:

 Cost or FMV of asset 40,000 – Present value of RV or BPO (1,470) = Payments cover 38,530 / PV factor of annuity due 3.5771 = Annual Payment 10,771

Use 8% / 4p
2,000 x PV of \$1 of 0.7350 = 1,470

The payment is lower because it does not have to cover the guaranteed RV.
This amount will be paid when the asset is returned, either with the asset or with cash.

B. Amortization Table:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$10,771 \$10,771 \$29,229 12/31/X1 \$10,771 \$2,338 \$ 8,433 \$20,796 12/31/X2 \$10,771 \$1,664 \$ 9,107 \$11,689 12/31/X3 \$10,771 \$934 \$ 9,837 \$ 1,852 12/31/X3 \$ 2,000 \$148 \$ 1,852 \$         0

C. Journal entries 1st Year

 Lessor Lessee Lease Receivable        \$40,000 Right of Use Asset         \$40,000 Asset                                \$40,000 Lease Payable                 \$40,000 Cash                              \$10,771 Lease Payable                \$10,771 Lease Receivable            \$10,771 Cash                              \$10,771 Cash                              \$10,771 Interest Expense             \$2,338 Lease Receivable          \$8,433 Lease Payable                \$8,433 Interest Revenue           \$2,338 Cash                              \$10,771 Amortization Expense   \$10,000 Right to Use Asset         \$10,000 (\$40,000 / 4 years)

D. Journal Entries for Asset Return at the End of the Lease

 Lessor: Cash              \$   500    GTD RV Asset             \$1,500    FMV Lease Receivable        \$1,852 Interest Revenue         \$   148 Lessee: Loss on Lease      \$500 Cash                \$500

Problem 4. Finance / Sales-type Lease without Sales Profit with Unguaranteed Residual Value

Same lease as problem 1, and the lease has a \$2,000 unguaranteed residual value.
At the end of the lease fair market value of the asset is \$1,500.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease and the second payment
D. Record the return of the asset at the end of the lease.

A. Calculate the lease payment:

 Cost or FMV of asset 40,000 – Present value of RV or BPO (1,470) = Payments cover 38,530 / PV factor of annuity due 3.5771 = Annual Payment 10,771

Use 8% / 4p

B. Amortization Table:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$10,771 \$10,771 \$29,229 12/31/X1 \$10,771 \$2,338 \$ 8,433 \$20,796 12/31/X2 \$10,771 \$1,664 \$ 9,107 \$11,689 12/31/X3 \$10,771 \$   934 \$ 9,837 \$ 1,852 12/31/X3 \$ 2,000 \$   148 \$ 1,852 \$         0

C. Journal entries 1st Year

 Lessor Lessee Lease Receivable        \$40,000 Right of Use Asset         \$40,000 Asset                                \$40,000 Lease Payable                 \$40,000 Cash                              \$10,771 Lease Payable                \$10,771 Lease Receivable            \$10,771 Cash                              \$10,771 Cash                              \$10,771 Interest Expense           \$2,338 Lease Receivable          \$8,433 Lease Payable              \$8,433 Interest Revenue           \$2,338 Cash                              \$10,771 Amortization Expense   \$10,000 Right to Use Asset         \$10,000 (\$40,000 / 4 years)

D. Journal Entries for Asset Return at the End of the Lease

 Lessor: Loss on lease          \$   500 Asset                       \$1,500 Lease Receivable        \$1,852 Interest Revenue          \$   148

The lessee did not guarantee the difference between the RV and FMV and does not pay this difference. The lessor records the asset at FMV and the difference as a loss in the period the asset is returned.

Problem 5. Finance / Sales-type without Sales Profit with Bargain Purchase Option

Assume the same lease as in problems 1. and the lease has a bargain purchase option of \$6,000 at the end of 2 years. The asset has an economic useful life of 6 years.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease and the second payment
D. Record the exercise of the bargain purchase option that ends the lease.

A. Calculate the lease payment:

Calculate the payment using 2 years as the period. You assume the buyout will occur and the lease will end with the purchase. The lease term is 2 years.

 Cost or FMV of asset 40,000 – Present value of RV or BPO (5,134) = Payments cover 34,866 / PV factor of annuity due 1.9259 = Annual Payment 18,099

Use 8% / 2p

B. Amortization Table:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$18,099 \$18,099 \$21,901 12/31/X1 \$18,099 \$1,752 \$ 16,347 \$ 5,554 12/31/X2 \$ 6,000 \$   446 \$ 5,554 \$       0

C. Journal entries 1st Year

 Lessor Lessee Lease Receivable        \$40,000 Right of Use Asset         \$40,000 Asset                                \$40,000 Lease Payable                 \$40,000 Cash                              \$18,099 Lease Payable                \$18,099 Lease Receivable            \$18,099 Cash                              \$18,099 Cash                              \$18,099 Interest Expense              \$ 1,752 Lease Receivable          \$16,347 Lease Payable                \$16,347 Interest Revenue           \$  1,752 Cash                              \$18,099 Amortization Expense   \$8,000 Right to Use Asset         \$8,000 (\$40,000 / 5 yr life of asset)

D. Journal Entries for Asset Return at the End of the Lease

 Lessor: Loss on lease          \$6,000 Asset                            \$5,554 Lease Receivable        \$   446 Lessee: Lease Liability                   \$5,554 Interest Expense    \$   446 Cash                                   \$6,000

The lessee did not guarantee the difference between the RV and FMV and does not pay this difference. The lessor records the asset at FMV and the difference as a loss in the period the asset is returned.

Problem 6. Sale-Leaseback Finance / Sales-type without Sales Profit

Lessee sells an asset for \$40,000 to another company and then leases it back at the FMV of \$40,000. The original cost of the asset to the lessee was \$30,000 and accumulated depreciation at the time of the sale is \$10,000. The lessee enters into a 4-year, 8% lease agreement with no residual value with the buyer.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all required journal entries for the first year of the lease.

A. Calculate the lease payment:

 Cost or FMV of asset 40,000 – Present value of RV or BPO 0 = Payments cover 40,000 / PV factor of annuity due 3.5771 = Annual Payment 11,182

Use 8% / 4p

B. Amortization Table:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$40,000 1/1/20X1 \$11,182 \$11,182 \$28,818 12/31/X1 \$11,182 \$2,305 \$ 8,877 \$19,941 12/31/X2 \$11,182 \$1,595 \$ 9,587 \$10,355 12/31/X3 \$11,182 \$   827 \$10,355 \$        0

C. Journal entries 1st Year

1st: Record the purchase and the sale of the asset:

 Lessor – Buyer Lessee – Seller Lease Receivable        \$40,000 Cash                                    \$40,000 Asset                                \$40,000 Accumulated Depreciation   \$10,000 Asset                                  \$30,000 Gain on sale of asset         \$20,000 2nd:  Record the first-year entries for the lease Lessor – Buyer Lessee – Seller Lease Receivable          \$40,000 Right of Use Asset         \$40,000 Asset                            \$40,000 Lease Payable                  \$40,000 Cash                              \$11,182 Lease Payable         \$11,182 Lease Receivable          \$11,182 Cash                          \$11,182 Cash                          \$11,182 Interest Expense      \$2,305 Lease Receivable      \$8,877 Lease Payable         \$8,877 Interest Revenue       \$2,305 Cash                          \$11,182 Amortization Expense   \$10,000 Right to Use Asset         \$10,000

Problem 7. Operating Lease

Lessor Company leased an asset to Lessee Company at the beginning of the year. Lessor’s cost of the asset (and PV of minimum lease payments) is \$10,000 and the asset’s fair value on the lease date is \$50,000. The lease term is 2 years and the useful life of the asset is 5 years. The lessee must make equal payments at the beginning of the lease and at the end of each year (annuity due). The agreement states no residual value. The effective rate of the lease is 8%. The lessor intends to lease the asset again after this lease ends.

A. Compute the annual lease payment
B. Prepare the amortization schedule
C. Record all journal entries for the first year of the lease.

A. Calculate the lease payment:

 Cost of asset 10,000 – Present value of RV or BPO 0 = Payments cover 10,000 / PV factor of annuity due 1.92593 = Annual Payment 5,192

Use 8% / 4p

B. Amortization Table:

 Payment Date Payments 8% Interest Decrease Outstanding Balance 1/1/20X1 \$10,000 1/1/20X1 \$5,192 \$5,192 \$ 4,808 12/31/X1 \$5,192 \$385 \$4,808 \$        0

C. Journal entries 1st Year

1st: Record the purchase and the sale of the asset:

 Lessor Lessee Beginning of lease: Right of Use Asset    \$10,000 No entry Lease Payable     \$10,000 Initial payment at beginning of lease: Cash                               \$5,192 Lease Payable          \$5,192 Deferred Revenue       \$5,192 Cash                          \$5,192 End of year: Deferred Revenue      \$5,192 Interest Expense       \$  384 Lease Revenue          \$5,192 Lease Payable          \$4,808 Cash                   \$5,192 Cash                               \$5,192 Deferred Revenue              \$5,192 Depreciation Expense           \$10,000 Amortization Expense      \$5,000 Accumulated Depreciation        \$10,000 Right of Use Asset                  \$5,000 (Cost / Useful life) (PV of MLP / useful life) \$10,000 / 2 years