On January 1, 2017, Pharoah Company leased equipment to Packer Corporation. The

Question

On January 1, 2017, Pharoah Company leased equipment to Packer Corporation. The following information pertains to this lease.

Both the lessor and the lessee’s accounting periods end on December 31.

1. The term of the noncancelable lease is 5 years. At the end of the lease term, Packer has the option to purchase the equipment for $9,000, while the expected residual value at the end of the lease is $14,000. 2. Equal rental payments are due on January 1 of each year, beginning in 2017. 3. The fair value of the equipment on January 1, 2017, is $210,000, and its cost is $158,000. 4. The equipment has an economic life of 6 years. Packer depreciates all of its equipment on a straight-line basis. 5. Pharoah set the annual rental to ensure a 6% rate of return. Packer’s incremental borrowing rate is 7%, and the implicit rate of the lessor is unknown. 6. Collectibility of lease payments by the lessor is probable.

Explanation / Answer

Pharoah Company Non callable lease term 5 Years Economic life of Equipment 6 Years Rate of Return 6% Cost of Equipment $ 1,58,000.00 Fair value of Equipment $ 2,10,000.00 Incremental borrowing rate 7% Conditions for Capital lease The Period of lease encompases at leaset 75% of useful life of assets. Sales Type Lease Sales type is a type of lease where the present value of minimum lease payment i.e the lease receivable for a lessor is higher than the carrying amount of leased assets. 1) Lease term is 75% of Assets economic life=(5/6) 83% 2) Fair value> Assets Cost=$210000>$158000 P.V of factor 1=.7473 P.v of annuity=(6% for 5 years) 4.46511 P.V od annuity(7% for 5 years) 4.38721 Annual Rental=($210000-($9000*.7473))/4.46511) $     45,525.04 General,Journal Date Particular Amt(Dr) Amt (Cr) 01-01-2014 Leased Equipment($45525.04*4.38721) $ 1,99,727.90    To Lease Liability $ 1,99,727.90 Lease Liability $     45,525.04     To Cash $     45,525.04 31-12-2014 Depreciation Expense($199727.90/5) $     39,945.58    To Accumulated Depreciation $     39,945.58 Interest Expense($199727.90-$39945.58)*.07 $     11,184.76     To Interest Payable $     11,184.76 01-01-2014 Lease Receivable $ 2,10,000.00 Cost of goods sold $     91,999.25    To Sales Revenue(($158000*-($14000.7473)) $ 1,43,999.25    To Inventory $ 1,58,000.00 Cash $     45,525.04     To Lease Receivable $     45,525.04 31-12-2014 Interest Receivable($210000-$45525.04)*.06 $       9,868.50      To Interest Revenue $       9,868.50

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