# At the beginning of 2018, VHF Industries acquired a machine with a fair value of \$7,989,010...

At the beginning of 2018, VHF Industries acquired a machine with a fair value of \$7,989,010 by signing a three-year lease. The lease is payable in three annual payments of \$3.1 million at the end of each year. (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. What is the effective rate of interest implicit in the agreement?
2-4. Prepare the lessee’s journal entries at the beginning of the lease, the first lease payment at December 31, 2018 and the second lease payment at December 31, 2019.
5. Suppose the fair value of the machine and the lessor’s implicit rate were unknown at the time of the lease, but that the lessee’s incremental borrowing rate of interest for notes of similar risk was 7%. Prepare the lessee’s entry at the beginning of the lease.

1)

 The Implicit Interest Rate = 8% Explanation : Present value of annuity * \$ 3,100,000 = \$ 7,989,010 Present value of annuity = \$ 7989010 / \$ 3100000 Present value of annuity = 2.5771 The discount rate for 3 payments that can be equal to 2.57710 is 8 %

2)

 Date General Journal Debit Credit 01-01-2018 Machine      To Lease Payable (To record beginning of lease ) \$ 7,989,010 \$ 7,989,010

3)

 Date Payment Interest(8%) Principal Balance 01-01-2018 7989010 12/31/2018 3100000 639121 (7989010*8%) 2460879 (3100000-639121) 5528131 12/31/2019 3100000 442250 (5528131*8%) 2657750 (3100000-442250) 2870381 12/31/2020 3100000 229619 (3100000-2870381) 2870381 0

4)

 Date General Journal Debit Credit 12/31/2018 Lease Payable Interest Expense               To       Cash (To record first lease payment at December 31,2018) 2460879 639121 3100000 12/31/2019 Lease Payable Interest Expense                 To     Cash (To record lease payment at December 31,2019) 2657750 442250 3100000

5)

Fair value of machine = \$3, 100,000 * Cumulative PV Factor at 7% for 3 periods

= \$3,100,000 * 2.624 = \$ 8134400

 Date General Journal Debit Credit 01-01-2018 Machinery        To Lease Payable (To record machinery purchased on lease) 8134400 8134400
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