Chapter 20, Problem 13P

1 (a)

To determine

Calculate the annual rental amounts.

Explanation of Solution

Compute the annual rental amount of Company L, as follows:

$\begin{array}{c}\text{Annul Rental Amount = }\frac{\text{Cost of Equipment}}{\text{PV}\text{}\text{factor for 6 receipts in advance at 14\%}}\\ \text{= }\frac{\$300,000}{4.433081}\\ \text{ = \$}67,673.02\end{array}$

Therefore, annual rental amount is $67,673.02.

1 (b)

To determine

Explain the way Company T should compute the present value of the lease rights and additional information required to make such calculation.

Explanation of Solution

To determine the present value of the lease rights, Company T should multiply the annual rental payment of $67,673.02 by the PV factor for 6 periods in advance at x%. That x% would be lesser than 14% or incremental borrowing rate of the Company T. Thus the incremental borrowing rate for Company T is the required additional information to compute the PV of lease rights.

2.

To determine

Prepare the table summarizing the lease and interest receipts that would be suitable for Company L.

Explanation of Solution

Prepare the table summarizing the lease and interest receipts that would be suitable for Company L:

Table (1)

Notes for the above table:

$\begin{array}{l}\text{Lease Receivable}\left(\text{January 01,2016}\right)=\text{ \$67,673}\text{.02}\times \text{6}\\ \text{Unearned Interest: Leases}\left(\text{January 01,2016}\right)=\$406,038.12-\$300,000.00\\ \text{Interest Revenue on Net Investment}\left(\text{December 31,2016}\right)\text{ = \$232,326}\text{.98}\times \text{14\%}\end{array}$

$\begin{array}{l}\text{Net Investment}\left(\text{Decemnber 31,2016}\right)\text{ = \$232,326}\text{.98+\$32,525}\text{.78}\\ \text{Interest Revenue on Net Investment}\left(\text{December 31,2020}\right)\text{ is adjusted for \$0}\text{.04 rounding error}\text{.}\end{array}$

The aforesaid table would also be suitable for Company T, if the incremental borrowing rate is $\ge$ 14% rate of return in the lease.

3.

To determine

Prepare journal entries suitable for Company L and Company T for the years 2016 and 2017.

Explanation of Solution

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit: Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Prepare journal entries suitable for Company L and Company T for the years 2016 and 2017:

Date	Accounts title and explanation	Post Ref.	Debit($)	Credit($)
January 1,2016	Leased Equipment		300,000.00
	Capital Lease Obligation			300,000.00
	(To record the capital lease at inception)
January 1,2016	Capital Lease Obligation		67,673.02
	Cash			67,673.02
	(To record the capital lease payment)
During Year	Insurance Expense		700.00
	Property Tax Expense		800.00
	Cash			1,500.00
	(To record the payment for executory costs)
December 31, 2016	Depreciation Expense: Leased Equipment		50,000.00
	Accumulated Depreciation: Equipment			50,000.00
	(To record the depreciation expense)
December 31, 2016	Interest Expense		32,525.78
	Accrued Interest on Capital Lease Obligation			32,525.78
	(To record the interest expense)
January 1,2017	Accrued Interest on Capital Lease Obligation		32,525.78
	Capital Lease Obligation		35,147.24
	Cash			67,673.02
	(To record the payment of accrued interest and lease payment)
During Year	Insurance Expense		600.00
	Property Tax Expense		750.00
	Cash			1,350.00
	(To record the payment for executory costs)
December 31, 2017	Depreciation Expense: Leased Equipment		50,000.00
	Accumulated Depreciation: Equipment			50,000.00
	(To record the depreciation expense)
December 31, 2017	Interest Expense		27,605.16
	Accrued Interest on Capital Lease Obligation			27,605.16
	(To record the interest expense)

Table (2)

Date	Accounts title and explanation	Post Ref.	Debit($)	Credit($)
January 1,2016	Equipment Leased to Others		300,000.00
	Cash			300,000.00
	(To record the payment of capital lease at inception)
January 1,2016	Lease Receivable		406,038.12
	Equipment Leased to Others			300,000.00
	Unearned Interest: Leases			106,038.12
	(To record the lease receivable in a capital lease)
January 1,2016	Cash		67,673.02
	Lease Receivable			67,673.02
	(To record the receipt lease payment)
December31, 2016	Unearned Interest: Leases		32,525.78
	Interest Revenue: Leases			32,525.78
	(To recognize the interest revenue for the year)
January 1,2017	Cash		67,673.02
	Lease Receivable			67,673.02
	(To record the receipt lease payment)
December 31, 2017	Unearned Interest: Leases		27,605.16
	Interest Revenue: Leases			27,605.16
	(To recognize the interest revenue for the year)

Table (3)

4.

To determine

Prepare income statements and ending balance sheets for both Company L and Company T for the year 2016 and 2017 with appropriate notes.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Balance Sheet: Balance Sheet is one of the financial statements which summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Income statements and ending balance sheets for Company T:

Company T
Comparative Income statement(Partial)
For the year ended December 31
	2017	2016
Interest Expense	$27,605.16	$32,525.78
Insurance Expense	600.00	700.00
Property Tax Expense	750.00	800.00
Depreciation Expense	50,000.00	50,000.00
Comparative Balance Sheet(Partial)
As on December 31
	2017	2016
Assets
Leased equipment less accumulated depreciation
(Notes 1 and 2)	$200,000.00	$250,000.00
Liabilities
Current:
Capital Lease Obligation	$67,673.02	$67,673.02
Non-Current:
Capital Lease Obligation(Notes 1 and 2)	$157,111.88	$197,179.74

Table (4)

Note 1: Description of Leasing Equipment:

Company T is leasing heavy equipment from Company L. The lease term is 6 years and 4 years are still remaining. There are no restrictions and no purchase option too in the lease. The heavy equipment reverts to Company L once the lease period is over.

Note 2: Capital Leases:

The leased property details are as follows:

	31.12.2017	31.12.2016
Heavy Equipment	$300,000.00	$300,000.00
Less: Accumulated amortization	$100,000.00	$50,000.00
Balance	$200,000.00	$250,000.00

Table (5)

Compute the present value of net lease payments under capital leases with future lease payments as of December 31, 2017 as per the following schedule:

December 31		Amount($)
2018		67,673.02
2019		67,673.02
2020		67,673.02
2021		67,673.02
Total Lease Payments		$270,692.08
Less: Amount that represent interest		(45,907.18)
Present value of lease payments(net)		$224,784.90

Table (6)

Income statements and ending balance sheets for Company L:

Company L
Comparative Income statement(Partial)
For the year ended December 31st
	2017	2016
Revenue:
Interest Revenue: Leases	27,605.16	32,525.78
Comparative Balance Sheet(Partial)
As on December 31st
	2017	2016
Current Assets
Net investment in direct financing leases
(Notes 1 and 2)	$67,673.02	$67,673.02
Non-Current Assets:
Net Investment in direct financing leases
(Notes1 and 2)	$157,111.88	$197,179.74

Table (7)

Note 1: Description of leasing arrangements:

Company L has leased the heavy equipment to Company T. The lease term is 6 years and 4 years are remaining. The heavy equipment reverts to Company L after the expiry of the lease.

Note 2: Net Investment in direct financing leases:

Following are the components of net investments in direct financing leases as on December 31 of the years as depicted in the schedule below:

	2017	2016
Total lease payment receivable	$270,692.08	$338,365.10
Less: Unearned interest: leases	45,907.18	73,512.34
Total lease payment receivable(net)	$224,784.90	$264,852.76

Table (8)