Mike Macinski Leasing Company leases a new machine that has a cost and fair valu
ID: 2724442 • Letter: M
Question
Mike Macinski Leasing Company leases a new machine that has a cost and fair value of $95,000 to Sharrer Corporation on a 3-year noncancelable contract. Sharrer Corporation agrees to assume all risks of normal ownership including such costs as insurance, taxes, and maintenance. The machine has a 3-year useful life and no residual value. The lease was signed on January 1, 2014. Mike Macinski Leasing Company expects to earn a 9% return on its investment. The annual rentals are payable on each December 31. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs.
A. Discuss the nature of the lease arrangement and the accounting method that each party to the lease should apply.
B. Pepare an amortiation schedule that would be suitable for both the lessor and the lessee and that covers all the years involved.
C. Prepare the journal entries on the lessee's bookds ot refflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2014 and 2015.
Explanation / Answer
a.The nature of the lease arrangement is that of a finance lease. This is because Sharrer Corporation (the lesse) will assume the risks of normal ownership. Maintenance is also not provided by the lessor.
Mike Macinski should, thus, use direct financing lease method. Lease receivable will be $95,000 and interest will be recognized annually.
b. Present value interest factor of annuity for 9% and 3 years = 2.531 (from PVIFA tables)
Annual payment will be = 95,000/2.531 = $37,534.57
Interest will be calculated on the opening balance of principal, at the rate of 9%. Thus, interest for the 1st year will be = 95,000*0.09 = $8550.
Principal paud during the year = total amount paid - interest amount. closing principal amount = opening principal - principal amount paid.
c. Entry for the signing of the lease agreement:
Fixed assets account (Dr) 95,000
Lease Payable account (Cr) 95,000
Entry on 31st December 2014:
Lease payable account (Dr) 28984.57
Interest account (Dr) 8550
Cash (Cr) 37534.57
Entry on 31st december 2015:
Lease payable account (Dr) 31593.18
Interest account (Dr) 5941.39
Cash (Cr) 37534.57
Entry on 31st december 2016:
Lease payable account (Dr) 34422.25
Interest account (Dr) 3112.33
Cash (Cr) 37534.57
Period Cash due Interest Principal Balance 0 95,000.00 1 37,534.57 8,550.00 28,984.57 66,015.43 2 37,534.57 5,941.39 31,593.18 34,422.25 3 37,534.57 3,112.33 34,422.25 0.00