Problem 15-8 Guaranteed residual value; direct financing lease [LO15-3, 15-5, 15-8]

On December 31, 2016, Rhone-Metro Industries leased equipment to Western Soya Co. for a four-year period ending December 31, 2020, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost Rhone-Metro $317,604 and has an expected useful life of six years. Its normal sales price is $317,604. The lessee-guaranteed residual value at December 31, 2020, is $30,000. Equal payments under the lease are $80,000 and are due on December 31 of each year. The first payment was made on December 31, 2016. Collectibility of the remaining lease payments is reasonably assured, and Rhone-Metro has no material cost uncertainties. Western Soyas incremental borrowing rate is 9%. Western Soya knows the interest rate implicit in the lease payments is 6%. Both companies use straight-line depreciation. Use (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1.	Show how Rhone-Metro calculated the $80,000 annual lease payments. (Enter your percentage answers as a whole number.)

Guaranteed Residual Value

Table or calculator function:

Drop down menu with these options: FV of $1, PV of $1, FVA of $1 , PVA of $1 , FVAD of $1, PVAD of $1

N=

I(%)=

Present Value

Amount to be recovered ? add present value of the guaranteed residual value? Or Less present value of the guaranteed residual value?

Amount to be recovered through periodic lease payments:

Lease Payments

Table or calculator function: Drop down menu with these options: FV of $1, PV of $1, FVA of $1 , PVA of $1 , FVAD of $1, PVAD of $1

N=

I(%)=

Lease Payments at the beginning of each year of the next four years?

2.	How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries (the lessor)?

Drop down menu for both: Capital lease, Capital lease: Direct financing lease, Capital Lease: Sales-Type lease, Operating Lease

3.	Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2016. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Western Soya Co. and Rhone-Metro Industries

Record lease December 31 2016

Record Cash payment December 31 2016

4.	Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and the lessor.

Lease Amortization Schedule

Dec.31 Payments Effective Interest Decrease in Balance Outstanding Balance

2016

2016

2017

2018

2019

2020

5.	Prepare all appropriate entries for both Western Soya and Rhone-Metro on December 31, 2017 (the second lease payment and depreciation). (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Western Soya Co.

Dec.31 2017 Record the cash payment

Dec 31 2017 Record the depreciation expense

Journal Entry for Rhino Metro Dec.31 2017 record cash received

6.	Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2020 assuming the equipment is returned to Rhone-Metro and the actual residual value on that date is $1,200. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Western Soya Co.

Dec. 31 2020

Record Depreciation Expense

Record the end of the lease

Rhone-Metro Industries

Dec.31 2020 Record the end of the lease