Question

Rhone-Metro Industries manufactures equipment that is sold or leased. On December 31, 2018, Rhone-Metro leased equipment to Western Soya Co. for a four-year period ending December 31, 2022, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost $425,000 to manufacture and has an expected useful life of six years. Its normal sales price is $487,946. The expected residual value of $22,000 at December 31, 2022, is not guaranteed. Equal payments under the lease are $136,000 (including $6,000 maintenance costs) and are due on December 31 of each year. The first payment was made on December 31, 2018. Western Soya’s incremental borrowing rate is 9%. Western Soya knows the interest rate implicit in the lease payments is 7%. Both companies use straight-line depreciation. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1. Show how Rhone-Metro calculated the $136,000 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)?

3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2018.

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, 2019 (the second lease payment and amortization).

6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2022, assuming the equipment is returned to Rhone-Metro and the actual residual value on that date is $1,000.

Answer 1

Dear student,

As per the Chegg Policy, only the first question should be answered. Kindly take note of it.

Part 1

Unguarnteed Residual Value

Table or Calculator Function	PV of $1
N =	4
I=	7%
	Present Value
Amount to be recovered	487946
Less: Present value of the unguaranteed residual value	(16784)
Amount to be Recovered through periodic lease payment	471162
Lease Payment
Table or Calculator Function	PVAD of $1
N =	4
I=	7%
	Lease Payments
Lease Payment at the beginning of four years	130000
Add: Maintenance costs	6000
Lease Payment including executory costs	136000

22000*0.76290 = 12206

Part 2

Western Soya Co.	Finance lease
Rhone-Metro Industries	Sales-type lease

It is a finance lease for Western Soya Co. present value is equal to fair market value

It is sales –type lease for Rhone-Metro Industries because cost and fair market value are not equal

Part 3

No	Date	General Journal	Debit	Credit
1	December 31, 2018	Right-of-Use asset	471162
		Lease payable		471162
2	December 31, 2018	Lease payable	130000
		Prepaid maintenance expense	6000
		Cash		136000

No	Date	General Journal	Debit	Credit
1	December 31, 2018	Lease receivable	487946
		Cost of goods sold (485000-16784)	468216
		Sales revenue (487946-16784)		471162
		Equipment		485000
2	December 31, 2018	Cash	136000
		Maintenance fees payable		6000
		Lease receivable		130000

Part 4

Lessee

Lease Amortization Schedule

Dec. 31	payments	Effective interest	Decrease in balance	Outstanding balance
2018				471162
2018	130000	0	130000	341162
2019	130000	23881	106119	235043
2020	130000	16453	113547	121496
2021	130000	8504	121496	0
	520000	48838	471162

Lessor

Lease Amortization Schedule

Dec. 31	payments	Effective interest	Decrease in balance	Outstanding balance
2018				487946
2018	130000	0	130000	357946
2019	130000	25056	104944	253002
2020	130000	17710	112290	140712
2021	130000	9850	120150	20562
2022	22000	1438	20562	0
	542000	54054	487946