Question

E21.23 (LOS) (Sale-Leaseback) Assume that on January 1, 2020. Elmer's Restaurants sells a com- puter system to Liquidity Finance Co. for $680,000 and immediately leases back the computer system. The relevant information is as follows. 1. The computer was carried on Elmer's books at a value of $600.000, 2. The term of the non-cancelable lease is 3 years, title will not transfer to Elmer's, and the expected residual value at the end of the lease is $450,000, all of which is unguaranteed. 3. The lease agreement requires equal rental payments of $115,970 at the beginning of each year. 4. The incremental borrowing rate for Elmer's is 8%. Elmer's is aware that Liquidity Finance set the annual rental to ensure a rate of return of 8%. 5. The computer has a fair value of $680,000 on January 1, 2020, and an estimated economic life of 10 years. Instructions Prepare the journal entries for both the lessee and the lessor for 2020 to reflect the sale and leaseback agreement

Answer 1

Elmer’s Restaurants (Seller-Lessee)

No.	Date	General journal	Debit	Credit
1	1/1/20	Cash	680000
		Equipment		600000
		Gain on sale of equipment		80000
2	1/1/20	Right-of-Use Asset	322775
		Lease Liability (115970*2.78326)		322775
3	1/1/20	Lease Liability	115970
		Cash		115970
4	12/31/20	Lease expense	115970
		Lease liability		16544
		Right-of-Use Asset		99426

Present value of an annuity due for 3 periods at 8% is 2.78326

Lease is treated as operating lease as not criterions for finance lease classification are met

Liquidity Finance Co. (Buyer-Lessor)

No.	Date	General journal	Debit	Credit
1	1/1/20	Equipment	680000
		Cash		680000
2	1/1/20	Cash	322775
		Unearned Lease Revenue		322775
3	12/31/20	Unearned Lease Revenue	115970
		Lease revenue		115970
4	12/31/20	Depreciation Expense	68000
		Accumulated Depreciation – Equipment ($680,000 ÷ 10)		68000

Lease is treated as operating lease as not criterions for sales-type lease classification are met