CHL
Corporation manufactures specialty equipment with an estimated economic life of
12 years and leases it to Provincial Airlines Corp. for a period of 10 years.
Both CHL and Provincial Airlines follow private enterprise GAAP. The
equipment’s normal selling price is $210,482 and its unguaranteed residual
value at the end of the lease term is estimated to be $15,000. Provincial
Airlines will pay annual payments of $25,000 at the beginning of each year and
all maintenance, insurance, and taxes. CHL incurred costs of $105,000 in
manufacturing the equipment and $7,000 in negotiating and closing the lease.
CHL has determined that the collectibility of the lease payments is reasonably
predictable, that no additional costs will be incurred, and that the implicit
interest rate is 8%.
Instructions
Answer
the following questions, rounding all numbers to the nearest dollar.
(a)
Discuss the nature of this lease in relation to the lessor and calculate the
amount of each of the following items:
1.
Gross investment
2.
Unearned interest income
3.
Sales price
4.
Cost of sales
(b)
Prepare a 10-year lease amortization schedule for the lease obligation using a
computer spreadsheet.
(c)
Prepare all of the lessor’s journal entries for the first year of the lease,
assuming the lessor’s fiscal year end is five months into the lease. Reversing
entries are not used.
(d)
Determine the current and non-current portion of the net investment at the
lessor’s fiscal year end, which is five months into the lease.
(e)
Assuming that the $15,000 residual value is guaranteed by the lessee, what
changes are necessary to parts (a) to (d)?
(a) The lease is a sales-type lease because: (1)
the lease term exceeds 75% of the asset’s estimated economic life, (2)
collectability of payments is reasonably assured and there are no further costs
to be incurred, and (3) CHL Corporation realized an element of profit aside
from the financing charge.
1. Gross
investment is $265,000 (10 annual lease payments of $25,000 each, plus the
unguaranteed residual value of $15,000).
2. Unearned
interest income, $76,880, is the gross investment of $265,000 less $188,120,
the fair market value of the asset and the initial present value of the
investment, calculated as follows:
Annual lease
payment $ 25,000
Present
value of an annuity due of $1 for
10 periods discounted at 8% 7.24689
Present
value of the 10 rental payments 181,172
Add present
value of estimated residual
value of $15,000 in 10 years at 8%
($15,000 X .46319) 6,948
Initial
present value $188,120
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Excel formula =PV(rate,nper,pmt,fv,type)
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Using a financial calculator:
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PV
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$
?
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Yields $188,120
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I
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8%
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N
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10
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PMT
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$
(25,000)
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FV
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$
(15,000)
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Type
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1
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3. Sales
price is $181,172 (the present value of the 10 annual lease payments); i.e. the
initial PV of $188,120 minus the PV of the unguaranteed residual value of
$6,948.
4. Cost
of sales is $98,052 (the $105,000 cost of the asset less the present value of
the unguaranteed residual value of $6,948).
(b) CHL CORPORATION (Lessor)
Lease Amortization
Schedule
Annuity Due Basis,
Unguaranteed Residual Value
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Beginning
of Year
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Annual Lease
Payment Plus
Residual Value
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Interest
(8%) on Net
Investment
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Net
Investment
Recovery
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Net
Investment
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Initial PV
1
2
3
4
5
6
7
8
9
10
End of 10
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(a)
—
$ 25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
15,000
$265,000
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(b)
—
—
*$ 13,050*
* 12,094*
* 11,061*
* 9,946*
* 8,742*
* 7,441*
* 6,036*
* 4,519*
* 2,881*
* 1,110*
*$76,880*
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(c)
—
$ 25,000
11,952
12,906
13,939
15,054
16,258
17,559
18,964
20,481
22,119
13,890
$188,120
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(d)
$188,120
163,120
151,170
138,264
124,325
109,271
93,013
75,454
56,490
36,009
13,890
0
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*Rounding
error is $1.
(a) Annual lease payment required by lease
contract.
(b) Preceding
balance of (d) X 8%, except beginning of first year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(c) Beginning
of Lease Year 1
Lease Payments Receivable.............. 265,000
Cost of Sales.......................... 98,052
Sales.............................. 181,172
Inventory.......................... 105,000
Unearned
Interest Income—Leases.... 76,880
(To record the sale and the cost of sales
in the lease transaction)
Selling Expense........................ 7,000
Cash............................... 7,000
(To record payment of the initial direct
costs relating to the lease)
Cash .................................. 25,000
Lease
Payments Receivable.......... 25,000
(To record receipt of the first lease
payment)
End of the
Year – 5 months after signing lease
Unearned Interest Income—Leases........ 5,438
Interest
Income—Leases............. 5,438
(To record interest earned during the
first year of the lease $13,050 X 5/12)
(d) The
balance of the net investment should be the net investment of $163,120 plus the
interest earned to the end of the year of $5,438, for a total of $168,558. This
should be reported as follows:
Current portion $17,388*
Non-current portion 151,170**
Total ($188,120 – $25,000 + $5,438) $168,558
* Lease payment receivable $25,000
Less unearned payment ($13,050 – $5,438)
7,612
Current Portion $17,388
** Non-current:
Total lease payments receivable $215,000
Less unearned ($76,880 – $13,050)
63,830
$151,170
(e) Assuming the $15,000 residual value was
guaranteed by the lessee, this would change the initial entry for the sale to
be as follows:
Lease Payments Receivable.............. 265,000
Cost of Sales.......................... 105,000
Sales.............................. 188,120
Inventory.......................... 105,000
Unearned
Interest Income—Leases.... 76,880
The sales and cost of goods sold would not need to be
reduced by the present value of the estimated residual value calculated in part
(a) of $6,948.
