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Lehman Dairy leases its milking equipment from Chavez Finance Company under the following lease terms. The lease term is 8 years, noncancelable, and requires equal
| Lehman Dairy leases its milking equipment from Chavez Finance Company under the following lease terms. | ||
| The lease term is 8 years, noncancelable, and requires equal rental payments due at the beginning of each year starting May 1, 2022. | ||
| The equipment has a fair value of $475,000, and cost Chavez $350,000, at the inception of the lease (May 1, 2022). | ||
| Lehman Dairy has the option to purchase the equipment for $12,600, at the end of the lease. This represents a signficant discount on the equipment. | ||
| The estimated economic life of the equipment is 10 years, and a residual value (which is guaranteed by Lehman Dairy) of $35,000. If the purchase option is not exercised, Lehman Dairy expects to pay $21,000 under the guaranteed residual value. | ||
| The lease contains no renewable options, and the equipment reverts to Chavez Finance Company upon termination of the lease, if the purchase option is not exercised. | ||
| Lehman Dairys incremental borrowing rate is 9% per year. Chavezs implicit rate is 7% and is known to Lehman Dairy. | ||
| Collectability of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. | ||
| Present value of 1 for 8 periods at 7% | 0.58201 | |
| Present value of 1 for 8 periods at 9% | 0.50187 | |
| Present value of an ordinary annuity for 8 periods at 7% | 5.97130 | |
| Present value of an ordinary annuity for 8 periods at 9% | 5.53482 | |
| Present value of an annuity due for 8 periods at 7% | 6.38929 | |
| Present value of an annuity due for 8 periods at 9% | 6.03295 | |
| Instructions | ||
| (Assume the accounting period ends on December 31.) | ||
| (a) Calculate the required payment Chavez Finance requires to earn the Fair Value of the asset. | ||
| (b) Lehman Dairy is able to negotiate the payment down to $73,000 per year. Compute the present value of the minimum lease payments for both the lessee and lessor. | ||
| (c) What type of lease is this for the lessee? For the lessor? | ||
| (d) Prepare the journal entries Chavez would make in the first full calendar year of the lease (January 1, 2023 - December 31, 2023) related to the lease arrangement. | ||
| (e) Prepare the journal entries Lehman would make in the first full calendar year of the lease (January 1, 2023 - December 31, 2023) related to the lease arrangement. | ||
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