Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2016, Rhone-Metro leased equipment to Western Soya Co. for a four-year period ending December 31, 2020, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost $300,000 to manufacture and has an expected useful life of six years. Its normal sales price is $365,760. The expected residual value of $25,000 at December 31, 2020, is not guaranteed. Equal payments under the lease are $104,000 (including $4,000 executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2016. Collectibility of the remaining lease payments is reasonably assured, and Rhone-Metro has no material cost uncertainties. Western Soya’s incremental borrowing rate is 12%. Western Soya knows the interest rate implicit in the lease payments is 10%. Both companies use straight-line depreciation. Required: 1. Show how Rhone-Metro calculated the $104,000 annual lease payments. 2. How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries (the lessor)? Why? 3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2016. 4. Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and the lessor. 5. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2017 (the second lease payment and depreciation). 6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2020, assuming the equipment is returned to Rhone-Metro and the actual residual value on that date is $1,500.
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2016, Rhone-Metro
leased equipment to Western Soya Co. for a four-year period ending December 31, 2020, at which time possession
of the leased asset will revert back to Rhone-Metro. The equipment cost $300,000 to manufacture and has
an expected useful life of six years. Its normal sales price is $365,760. The expected residual value of $25,000 at
December 31, 2020, is not guaranteed. Equal payments under the lease are $104,000 (including $4,000 executory
costs) and are due on December 31 of each year. The first payment was made on December 31, 2016.
Collectibility of the remaining lease payments is reasonably assured, and Rhone-Metro has no material cost
uncertainties. Western Soya’s incremental borrowing rate is 12%. Western Soya knows the interest rate implicit
in the lease payments is 10%. Both companies use straight-line
Required:
1. Show how Rhone-Metro calculated the $104,000 annual lease payments.
2. How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries
(the lessor)? Why?
3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2016.
4. Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and
the lessor.
5. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2017 (the second
lease payment and depreciation).
6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2020, assuming the
equipment is returned to Rhone-Metro and the actual residual value on that date is $1,500.
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