Question

Part 2: Classifying Leases 1. Lessee Co. leases a common piece of machinery from Lessor Corp. The lease begins on January 1, 2019, and includes the following details: • The lease has a term of four years and is non-cancelable. • The lease contains no renewal or purchase options. The machinery reverts to Lesson Corp. at the termination of the lease. • The machinery has a fair value at commencement of the lease of $40,000, an estimated economic life of four years, and no residual value. The cost of the machinery on Lesson Corp.'s books is $30,000. • Rental payments of $11,182 are due at the beginning of each year, starting on January 1, 2019. The collectibility of the payments is probable. • Lessor Corp. uses an implicit interest rate of 8% to set the rental payments. This rate is known by Lessee Co. . Both parties have policies of using straight-line depreciation when accounting for similar pieces of machinery. Determine whether this lease should be classified as an operating lease or a finance/sales-type lease.

Answer 1

Answer Determine whether this lease should be classified as an operating Tease or a finance/ sales type lease - Present Value of minimum Lease payments Present value Year Annual Lease payments present Value Factor @ 8% 0.9259259 0.8573388 $ 11182 $10354 $9587 $ 182 $11182 $11182 $11182 $11182 0.7938322 0.7350298 I $8219 $ 48219 $ 55910 - So, It is a finance / sales-type lease because present Value of Lease Tental payments is equal to the fair value of leased machinery. since, Lease term is equal → SO, It is a finance Sales-type lease because present value of Lease sental payments is equal to the fair value of leased machinery since, Lease term is also equal to the useful life of leased machinery. There fore, This Lease is a Finance / sales tybe lease.

In the books of Lessee Co. Journal Entries Particulars ra: Debit Credit Date 2019 Janl. 40000 40000 Leased Machinery ale Dr. To Lease liability arc (Being lease agreement recorded) Lease liability are Dr. To cash ale (3eing first lease payment made at beginning of the lease) 11182 Jant 11192 2305 2305 loooo 0 000 Decal. Finance charges are Dr. To Finance charges pay able alc (Being adiustment made for Accrued Interest charges Dec 31. Depreciation Expense ale Dv. To Leased Equipment all Being Depreciation charged on Machinery Decal. I profit and Loss ale Dr. To Finance charges ale I To Depreciation charges ale | CBeing all Expenses written off) | 12305 2305 10000

11182 1595 1595 2020 8877 Janl. Lease liability ale Dr. Finance charges payable al 2305 To cash alc (Being Lease payment made Dec 31. Finance charges ac Dr. To Finance charges payable all (Being adjustment made For acerued Interest) Depreciation Expense ale by To leased Machinery ale ( Being Depreciation charged | Dec31. profit and Loss all Dr. To Finance charges are To Depreciation Expenses al CBeing an leased expenses written off) 10000 loooo 11595 1595 10000 2021 9587 1595 11182 Jani. | Lease Liability ale Dr. Finance charges payable arc Dr. To cash all ( Being lease payment made) Decal, Finance charges are Dy. To Finance charges bayable are Being Adiustment made For Accrued Interest) 828 828

loooo 828 10000 Dec.31. Depreciation Expense Dr, 10000 To Leased Machinery arc C Being Depreciation charged) Dec 31. profit and Loss ale Dr. 10828 To Finance charges ac To Debreciation Expensee (Being all expenses were written off) 2022 Jani. Lease liability and Dr. 10354 Finance charges payable . 828 To cash ale ( Being Lease payment) I alc 11182 made

In the books of Lessor Co. Journal Entries Date particulars Debit credit 2019 Jani. 40000 Jan. 1182 11182 Lease receivable and Dr. 40000 To I Machinery al C Being Lease agreement made) * Cash ale Dr. To Lease receivable at (Being. First lease rental collected) Finance Income receivable all Dr. 2305 To Finance Income alc ( Being Adjustment made for acerued finance Income) Dec 31. 2305 2305 Decal. Finance Income al 34. To profit and Loss al (Being Finance Income og transferred) 2305 2020 Jant. 11182 8877 Cash ac Dr. To lease receivable al To Finance Income receivable ad | ( Being Lease payment received) 2305

1595 1595 Dec31. Finance thcom receivable alco To Finance Income alc C Being adjustment made for Finance Income) 1595 Decal. 1545 Finance Income all Dr. To profit and loss ale (Being Finance Income transferred)

2021 11182 Jant. I cash ale Dr. To lease receivable all To Finance Income receivable (Being lease payment received) 9587 1595 Qic 828 Dec31. Finance Income receivable ale Dr. To Finance Income ale (Being adjustment made for) o accrued Finance Income 828 Dec 31. 828 Finance Income alc Dr. To profit and Lossal CBeing Finance Income transferred 828

2022 1182 10354 Janl. 828 cash ale Dr. To lease receivable arc TO Finance Income alc (Being Finance Income & transferred)