Chapter 20, Problem 5P

1.

To determine

Prepare a table summarizing the lease receipts and interest revenue earned by the lessor for the direct financing lease.

Explanation of Solution

Prepare a table summarizing the lease receipts and interest revenue earned by the lessor for the direct financing lease:

Table (1)

Notes to the above table:

$\begin{array}{l}\text{Lease Receivable}\left(\text{January 01,2016}\right)\text{ is the undiscounted value of the lease payments along with }\\ \text{the unguranteed residual value}\text{.}\\ \text{Net Investment}\left(\text{January 01,2016}\right)\text{ is the present value of the lease payments along with the }\\ \text{Present value of the unguranteed residual value}\text{.}\\ \text{Revenue on Net Investment}\left(\text{December 31,2016}\right)\text{ = \$308,021}\text{.03}\times \text{15\%}\\ \text{Reduction on Net Investment}\left(\text{December 31,2016}\right)\text{ = \$65,000}\text{.00}-\text{\$46,203}\text{.15}\end{array}$$\begin{array}{l}\text{Lease Receivable}\left(\text{December 31,2016}\right)\text{ = \$570,000}-\text{\$65,000}\\ \text{Unearned Interest: Leases}\left(\text{December 31,2016}\right)\text{ = \$261,978}\text{.97}-\text{\$46,203}\text{.15}\\ \text{Net Investment}\left(\text{December 31,2016}\right)\text{ = \$308,021}\text{.03}-\text{\$18,796}\text{.85}\\ \text{Revenue on Net Investment}\left(\text{December 31,2023}\right)\text{ is adjusted for \$0}\text{.13 rounding error}\text{.}\end{array}$

$\text{Net Investment}\left(\text{December 31,2023}\right)\text{ is the unguranteed residual value}\text{.}$

2.

To determine

Explain the reasons for classifying the lease as a direct financing lease.

Explanation of Solution

Direct Financing Lease: Under direct financing lease, the lessor considers the lease as a sale of the asset at fair value equal to the cost of the asset or its carrying value and records an accompanying receivable. Since there is no manufacture’s or dealer’s profit or loss, the lessor records the net amount at which the receivable must be equal to the cost of the asset or carrying value of the property.

The reasons for classifying the lease as direct financing lease from the criteria table as presented below:

Capitalization Criteria	Met or not	Remarks
1. Transfer of ownership at the end of lease	No
2. Bargain purchase option	No
3. Lease term is 75% or more	Yes	89% $\left(\text{8years/9years}\right)$
4. Present value of lease payment is 90% or more of the fair value	Yes	PV is 94.7% of the fair value of the equipment
Recognition Criteria
1. Collectivity assured	Yes
2. No Uncertainties	Yes

Table (2)

From the above table, it is noted that the lease is a direct financing lease for Company C as more than one capitalization criteria is met and both of the recognition criteria also met according to the terms of the lease agreement. Moreover there is a dealer’s profit of $$350,090.68$\left(\$185,090.68-\$150,000\right)$ due to the difference between the PV of the lease payments and the cost of the asset for Company C.

Working Note 1: Compute the present value of minimum lease payment:

$\begin{array}{c}\text{PV}\text{}\text{of the minimum lease payments }=\text{ \$65,000}\times \text{PV}\text{}\text{factor of 8 payments at 15\%}\\ =\$65,000\times 4.487322\\ =\$291,675.93\end{array}$

3.

To determine

Prepare the journal entries for Company C for the years 2016, 2017, and 2018.

Explanation of Solution

Prepare the journal entries for Company C for the years 2016, 2017, and 2018:

Date	Accounts title and explanation	Post Ref.	Debit($)	Credit($)
January 1,2016	Equipment Leased to Others		308,021.03
	Cash			308,021.03
	(To record the payment of capital lease at inception)
January 1,2016	Lease Receivable		570,000.00
	Equipment Leased to Others			308,021.03
	Unearned Interest: Leases			261,978.97
	(To record the lease receivable in a capital lease)
December 31,2016	Unearned Interest: Leases		46,203.15
	Interest Revenue: Leases			46,203.15
	(To recognize the interest revenue of the year)
December 31,2016	Cash		65,000.00
	Lease Receivable			65,000.00
	(To record the receipt of final lease payment )
December 31,2017	Cash		65,000.00
	Lease Receivable			65,000.00
	(To record the receipt of final lease payment )
December 31,2017	Unearned Interest: Leases		43,383.63
	Interest Revenue: Leases			43,383.63
	(To recognize the interest revenue of the year)
December 31,2018	Cash		65,000.00
	Lease Receivable			65,000.00
	(To record the receipt of final lease payment )
December 31,2018	Unearned Interest: Leases		40,141.17
	Interest Revenue: Leases			40,141.17
	(To recognize the interest revenue of the year)

Table (3)

4.

To determine

Prepare a partial balance sheet for December 31, 2016 and December 31, 2017 showing the reported accounts in it.

Explanation of Solution

Balance Sheet:  Balance Sheet is one of the financial statements which summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare a partial balance sheet for December 31, 2016 and December 31, 2017 showing the reported accounts in it:

Company C
Balance Sheet(Partial)
As on December 31
Particulars	2016	2017
Assets
Current Assets:
Net Investment in Direct Financing Leases	$56,521.73	$56,521.73
Non-Current Assets:
Net Investment in Direct Financing Leases	$211,086.08	$232,702.45
Liabilities
Current liabilities:
Non-Current liabilities:

Table (4)

Notes for the above table:

$\begin{array}{c}\begin{array}{l}\text{Net Investment in Direct}\\ \text{Financing Leases: Current}\left(2016\text{ and 2017}\right)\end{array}\}\text{= \$65,000}\times \text{0}\text{.869565}\\ \begin{array}{l}\text{Net Investment in Direct }\\ \text{Financing: Leases: Non-current}\left(2016\right)\end{array}\}\text{= \$289,224}\text{.18}-\text{\$56,521}\text{.73}\\ \begin{array}{l}\text{Net Investment in Direct }\\ \text{Financing: Leases: Non-current}\left(2017\right)\end{array}\}=\text{ \$267,607}\text{.81}-\text{\$56,521}\text{.73}\end{array}$

$\begin{array}{l}\text{For 2016, the amounts are calculated by the "change in present value approach" }\\ \text{which are \$21,616}\text{.37 ans \$267,607}\text{.81 respectively}\text{.}\\ \\ \text{For 2017, the amounts are calculated by the "change in present value approach" }\\ \text{which are \$24,858}\text{.83 ans \$242,748}\text{.98 respectively}\text{.}\end{array}$