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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.

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ReportAnswer #1

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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