Tamarisk Leasing Company agrees to lease equipment to Vaughn Corporation on January 1, 2020. The following information relates to the lease agreement. 1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
2. The cost of the machinery is $541,000, and the fair value of the asset on January 1, 2020, is $760,000.
3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $45,000. Vaughn estimates that the expected residual value at the end of the lease term will be 45,000. Vaughn amortizes all of its leased equipment on a straight-line basis.
4. The lease agreement requires equal annual rental payments, beginning on January 1, 2020.
5. The collectibility of the lease payments is probable.
6. Tamarisk desires a 10% rate of return on its investments. Vaughn’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

(Assume the accounting period ends on December 31.)

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Discuss the nature of this lease for both the lessee and the lessor.

This is a operating leasesales-type leasefinance lease for Vaughn.

This is a sales-type leaseoperating leasefinance lease for Tamarisk.

eTextbook and Media

List of Accounts

Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e. g. 1.25124 and the final answer to 0 decimal places e. g. 58,972.)

Annual rental payment
$

eTextbook and Media

List of Accounts

Compute the value of the lease liability to the lessee. (Round present value factor calculations to 5 decimal places, e. g. 1.25124 and the final answer to 0 decimal places e. g. 58,972.)

Present value of minimum lease payments
$

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List of Accounts

Prepare the journal entries Vaughn would make in 2020 and 2021 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e. g. 58,972. Record journal entries in the order presented in the problem.)

Date

Account Titles and Explanation

Debit

Credit

1/1/2012/31/201/1/2112/31/21

(To record the lease.)

(To record lease payment.)

1/1/2012/31/201/1/2112/31/21

(To record amortization.)

(To record interest.)

1/1/2012/31/201/1/2112/31/21

1/1/2012/31/201/1/2112/31/21

(To record amortization.)

(To record interest.)

eTextbook and Media

List of Accounts

Prepare the journal entries Tamarisk would make in 2020 and 2021 related to the lease arrangement. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places e. g. 58,972. Record journal entries in the order presented in the problem.)

Date

Account Titles and Explanation

Debit

Credit

1/1/2012/31/201/1/2112/31/21
(To record the lease.)

1/1/2012/31/201/1/2112/31/21
(To record lease payment.)

1/1/2012/31/201/1/2112/31/21

1/1/2012/31/201/1/2112/31/21

1/1/2012/31/201/1/2112/31/21

1. Finance lease to Vaughn Corporation

Sales-type lease

2. Annual Rental = $ 137,604

3. Lease Liability = $ 741,418

4. Vaughn Corporation.

2020

Jan. 1

Dr Lease Equipment$741,418

Cr Lease Liability $741,418

Jan. 1

Dr Lease Liability$137,064

Cr Cash $137,064

Dec. 31

Dr Depreciation Expense$99,488

Cr Accumulated Depreciation - Finance Lease $99,488

Dec. 31

Dr Interest Expense$66,479

Cr Interest Payable $66,479

2021

Jan. 1

Dr Lease Liability$70,585

Dr Interest Payable$66,479

Cr Cash $137,064

Dec. 31

Dr Depreciation Expense$99,488

Dr Accumulated Depreciation - Finance Lease $99,488

Dec. 31

DrInterest Expense$58,715

Dr Interest Payable $58,715

5. Tamarisk Leasing Company.

2020

Jan. 1

Dr Lease Receivable$760,000

Dr Cost of Goods Sold$541,000

Cr Sales Revenue $760,000

Cr Inventory $541,000

Jan. 1

DrCash$137,064

Cr Lease Receivable $137,064

Dec. 31

DrInterest Receivable$62,294

Cr Interest Revenue $62,294

2021

Jan. 1

Dr Cash$137,064

Cr Lease Receivable $74,770

Cr Interest Receivable $62,294

Dec. 31

Dr Interest Receivable$54,817

Cr Interest Revenue $54,817

Explanation:

1. Discussion of the nature of this lease for both the lessee and the lessor.

(i) Based on the information given it is a Finance lease to Vaughn Corporation reason been that the term of the lease is higher than 75% of the leased asset economic life based on the fact that the term of the leaseis 78% calculated as (7/9).

(ii) Based on the information given Tamarisk Leasing Company reason been the lease payments can be predictable because their are no uncertainties concerning the costs that is yet to be incurred by the lessor, and secondly the term of the lease is higher than 75% of the asset’s economic life because the amount of $ 760,000 of the equipment is above the lessor’s cost of the amount of $ 541,000 which is why the lease is a Sales-type lease

2. Calculation of Annual Rental Payment

Annual Rental = {FV - (RV * PVF(n=7 years, r=10%))} / PVADF(n=7 years, r=10%)

Annual Rental = {$ 760,000 - ($ 45,000 * 0.51316} / 5.35526

Annual Rental = $ 137,604

3. Calculation of Lease Liability to the Lessee.

First step

Present Value of Annual Payments = $ 137,604 * PVADF(n= 7 years, r=11%)

Present Value of Annual Payments = $ 137,604 *5.23054

Present Value of Annual Payments = $ 719,743

Present Value of Guaranteed Residual Value = $ 45,000 * PVF(n= 7 years, r=11%)

Present Value of Annual Payments = $ 45,000 * .48166

Present Value of Annual Payments = $ 21,675

Hence,

Lease Liability = $ 719,743 + $ 21,675

Lease Liability = $ 741,418

4. Preparation of the Journal Entries for Vaughn Corporation.

2020

Jan. 1

Dr Lease Equipment$741,418

Cr Lease Liability $741,418

Jan. 1

Dr Lease Liability$137,064

Cr Cash $137,064

Dec. 31

Dr Depreciation Expense$99,488

Cr Accumulated Depreciation - Finance Lease $99,488

($ 741418 - $ 45,000) ÷ 7 years

Dec. 31

Dr Interest Expense$66,479

Cr Interest Payable $66,479

($ 741418 - $ 137,064) * 11%

2021

Jan. 1

Dr Lease Liability$70,585

Dr Interest Payable$66,479

Cr Cash $137,064

Dec. 31

Dr Depreciation Expense$99,488

Dr Accumulated Depreciation - Finance Lease $99,488

Dec. 31

DrInterest Expense$58,715

Dr Interest Payable $58,715

($ 741418 - $ 137,064 - $ 70,585) * 11%

5. Preparation of the Journal Entries for Tamarisk Leasing Company.

2020

Jan. 1

Dr Lease Receivable$760,000

Dr Cost of Goods Sold$541,000

Cr Sales Revenue $760,000

Cr Inventory $541,000

Jan. 1

DrCash$137,064

Cr Lease Receivable $137,064

Dec. 31

DrInterest Receivable$62,294

Cr Interest Revenue $62,294

($ 760,000 - $ 137064) * 10%

2021

Jan. 1

Dr Cash$137,064

Cr Lease Receivable $74,770

Cr Interest Receivable $62,294

Dec. 31

Dr Interest Receivable$54,817

Cr Interest Revenue $54,817

($ 760,000 - $ 137064 - $ 74,770) * 10%

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