Question

Tamarisk Leasing Company agrees to lease equipment to Vaughn Corporation on January 1, 2020. The following information relates to the lease agreement.

1.		The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
2.		The cost of the machinery is $541,000, and the fair value of the asset on January 1, 2020, is $760,000.
3.		At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $45,000. Vaughn estimates that the expected residual value at the end of the lease term will be 45,000. Vaughn amortizes all of its leased equipment on a straight-line basis.
4.		The lease agreement requires equal annual rental payments, beginning on January 1, 2020.
5.		The collectibility of the lease payments is probable.
6.		Tamarisk desires a 10% rate of return on its investments. Vaughn’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31.)

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Discuss the nature of this lease for both the lessee and the lessor.

This is a                                                                       operating leasesales-type leasefinance lease for Vaughn.

This is a                                                                       sales-type leaseoperating leasefinance lease for Tamarisk.

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Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,972.)

Annual rental payment

$

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Compute the value of the lease liability to the lessee. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,972.)

Present value of minimum lease payments

$

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Prepare the journal entries Vaughn would make in 2020 and 2021 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,972. Record journal entries in the order presented in the problem.)

Date	Account Titles and Explanation	Debit	Credit
1/1/2012/31/201/1/2112/31/21
	(To record the lease.)
	(To record lease payment.)
1/1/2012/31/201/1/2112/31/21
	(To record amortization.)
	(To record interest.)
1/1/2012/31/201/1/2112/31/21
1/1/2012/31/201/1/2112/31/21
	(To record amortization.)
	(To record interest.)

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Prepare the journal entries Tamarisk would make in 2020 and 2021 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e.g. 58,972. Record journal entries in the order presented in the problem.)

Date	Account Titles and Explanation	Debit	Credit
1/1/2012/31/201/1/2112/31/21
	(To record the lease.)
1/1/2012/31/201/1/2112/31/21
	(To record lease payment.)
1/1/2012/31/201/1/2112/31/21
1/1/2012/31/201/1/2112/31/21
1/1/2012/31/201/1/2112/31/21

Answer 1

1. Nature of Lease for both the lessor and lessee.
(i) This is a Finance lease to Vaughn Corporation since the lease term is greater than 75% of the economic life of the leased asset. The lease term is 78% (7÷9) of the asset’s economic life.
(ii) For Tamarisk Leasing Company, since the collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is greater than 75% of the asset’s economic life. Since the fair value ($ 760,000) of the equipment exceeds the lessor’s cost ($ 541,000), the lease is a Sales-type lease
2. Calculation of Annual Rental Payment.
Annual Rental = {FV - (RV * PVF(n=7 years, r=10%))} / PVADF(n=7 years, r=10%)
Here,
FV = Fair Value of the asset
RV = Residual Value of the asset at the end of the lease term.
Annual Rental = {$ 760,000 - ($ 45,000 * 0.51316} / 5.35526
Annual Rental = $ 137,604
3. Calculation of Lease Liability to the Lessee(Present Value of Minimum Lease Payments.
Present Value of Annual Payments = $ 137,604 * PVADF(n= 7 years, r=11%)
Present Value of Annual Payments = $ 137,604 * 5.23054
Present Value of Annual Payments = $ 719,743
Now,
Present Value of Guaranteed Residual Value = $ 45,000 * PVF(n= 7 years, r=11%)
Present Value of Annual Payments = $ 45,000 * .48166
Present Value of Annual Payments = $ 21,675
Therefore,
Lease Liability = $ 719,743 + $ 21,675
Lease Liability = $ 741,418
4. Journal Entries for Vaughn Corporation.
Date	Particulars	Debit ($ )	Credit ($ )
2020
Jan. 1	Lease Equipment	$741,418
	Lease Liability		$741,418
Jan. 1	Lease Liability	$137,064
	Cash		$137,064
Dec. 31	Depreciation Expense	$99,488
	Accumulated Depreciation - Finance Lease		$99,488
	($ 741418 - $ 45,000) ÷ 7 years
Dec. 31	Interest Expense	$66,479
	Interest Payable		$66,479
	($ 741418 - $ 137,064) * 11%
2021
Jan. 1	Lease Liability	$70,585
	Interest Payable	$66,479
	Cash		$137,064
Dec. 31	Depreciation Expense	$99,488
	Accumulated Depreciation - Finance Lease		$99,488
Dec. 31	Interest Expense	$58,715
	Interest Payable		$58,715
	($ 741418 - $ 137,064 - $ 70,585) * 11%
5. Journal Entries for Tamarisk Leasing Company.
Date	Particulars	Debit ($ )	Credit ($ )
2020
Jan. 1	Lease Receivable	$760,000
	Cost of Goods Sold	$541,000
	Sales Revenue		$760,000
	Inventory		$541,000
Jan. 1	Cash	$137,064
	Lease Receivable		$137,064
Dec. 31	Interest Receivable	$62,294
	Interest Revenue		$62,294
	($ 760,000 - $ 137064) * 10%
2021
Jan. 1	Cash	$137,064
	Lease Receivable		$74,770
	Interest Receivable		$62,294
Dec. 31	Interest Receivable	$54,817
	Interest Revenue		$54,817
	($ 760,000 - $ 137064 - $ 74,770) * 10%