Exercise 3. Lessee (Finance Lease) and Lessor (Sales-Type Lease)

On 1/1, Year 1, a lessee engages in a finance lease with a lessor who accounts for the lease as sales-type lease. The lease is an annuity due lease for 10 years. The annual lease payments are $20,000. The first annual lease payment of $20,000 is on 1/1, Year 1, and the remaining payments are on 12/31 (i.e., the second annual lease payment is on 12/31, Year 1.) There is $8,000 guaranteed residual value. The interest rate implicit in the lease, which the lessee is aware of is 8%, thus a present value factor of an annuity due of 7.2469 and the present value of a single sum 0.4631.

The fair market value and cash selling price of the equipment is $148,643, which is also the present value of the minimum lease payments for the lessee and the net investment for the lessor. The inventory carrying value of the equipment on the lessors books is $70,000. Round to the nearest whole dollar.

Prepare the amortization table shown below for the first three years of the lease and the journal entries for the lessee and lessor on the following pages for the dates indicated.

Date	Lease payment	Interest Expense or Interest Revenue	Amortization	Carrying value of lease liability and net investment
1/1/Yr 1				$
1/1/Yr 1	$		$	$
12/31/Yr 1	$	($_________ X ___ = ) $_________	$	$
12/31/Yr 2	$	($_________ X ___ = ) $_________	$	$
12/31/Yr 3	$	($_________ X ___ = ) $_________	$	$

Check figures: Note that unlike the previous exercise the payments and the recognition of interest all occur on 12/31 of each year. There is no payment on 1/1 of each year and thus no journal entry on 1/1 either. The carrying value of lease obligation on 12/31, Year 3, should be $97,125.

On the next page prepare the journal entries for the dates indicated. The following accounts are used for each party.

For Lessee: CASH INTEREST EXPENSE RIGHT-OF-USE ASSET LEASE LIABILITY

For Lessor: CASH COST OF GOODS SOLD INTEREST REVENUE EQUIPMENT or INVENTORY LEASE RECEIVABLE SALES

Lessee Journal Entries Finance Lease:

1. Prepare the journal entries on 1/1, Year 1.

2. Prepare the journal entry on 12/31, Year 1.

3. Prepare the journal entry on 12/31, Year 2.

4. Prepare the journal entry on 12/31, Year 3.