Problem 15-1 Direct financing & sales-type lease; lessee and lessor L015-3 LO15-
ID: 2601718 • Letter: P
Question
Problem 15-1 Direct financing & sales-type lease; lessee and lessor L015-3 LO15-5 LO15-6 Text: P 15-3 Tech-Knowledgies voice recognition hardware from Tech-Knowledgies for $500,000 and leased it to Pal Learning Systems on January 1, 2016. Lease description: Quarterly rental payments $32,629-beginning of each period develops and manufactures voice recognition hardware. Star Leasing purchased a Lease term 5 years (20 quarters) No residual value; no BPO Economic life of lithotripter 5 years Implicit interest rate and lessee's incremental borrowing rate 12% Fair value of asset$500,000 Collectibility of the rental payments is reasonably assured, and there are no lessor costs yet to be incurred. Note: 15.32380 = present value of an annuity due of $1: n:20, 3% Required: 1.How should this lease be classified by Pal Learning Systems and by Star Leasing? 2. Prepare appropriate entries for both Pal Learning Systems and Star Leasing from the inception of the lease through the second rental payment on April 1, 2016. Depreciation is recorded at the end each fiscal year (December 31). Assume Pal Learning Systems leased the hardware directly from the manufacturer, Tech-Knowled which produced the machine at a cost of $450,000. Prepare appropriate entries for Tech-Knowled from the inception of the lease through the second rental payment on April 1,2016.Explanation / Answer
Requirement 1
Capital lease to lessee; Direct financing lease to lessor.
Since the present value of minimum lease payments (same for both the lessor and the lessee) is equal to (>90%) the fair value of the asset, the 90% recovery criterion is met.
Calculation of the Present Value of Minimum Lease Payments
Present value of periodic rental payments
$32,629 x 15.32380** = $500,000
(rounded)
** present value of an annuity due of $1: n=20, i=3%
The 75% of useful life criterion is met also. Both additional lessor conditions are met for a nonoperating lease. There is no dealer’s profit because the fair value equals the lessor’s cost.
Requirement 2
Pal Learning Systems (Lessee)
January 1, 2016
Leased equipment (calculated above)............................. 500,000
Lease payable (calculated above)................................ 500,000
Lease payable ........................................................... 32,629
Cash (rental payment)................................................ 32,629
April 1, 2016
Interest expense (3% x [$500,000 – 32,629]).......................... 14,021
Lease payable (difference)............................................ 18,609
Cash (rental payment)................................................ 32,629
Star Leasing (Lessor)
January 1, 2016
Lease receivable ($32,629 x 20)..................................... 652,580
Unearned interest revenue ($652,580 - 500,000)......... 152,580
Inventory of equipment (lessor’s cost)....................... 500,000
Cash (rental payment).................................................... 32,629
Lease receivable .................................................... 32,629
April 1, 2016
Cash (rental payment).................................................... 32,629
Lease receivable .................................................... 32,629
Unearned interest revenue ........................................ 14,021
Interest revenue (3% x [$500,000 – 32,629])..................... 14,021
Requirement 3
Star Leasing (Lessor)
January 1, 2016
Lease receivable ($32,629 x 20)..................................... 652,580
Cost of goods sold (lessor’s cost).................................. 450,000
Sales revenue (fair market value)................................ 500,000
Unearned interest revenue ($652,580 - 500,000)......... 152,580
Inventory of equipment (lessor’s cost)....................... 450,000
Cash (rental payment).................................................... 32,629
Lease receivable .................................................... 32,629
April 1, 2016
Cash (rental payment).................................................... 32,629
Lease receivable .................................................... 32,629
Unearned interest revenue ........................................ 14,021
Interest revenue (3% x [$500,000 – 32,629])..................... 14,021