Question

The lease agreement specified quarterly payments of $5,000 beginning September 30, 2018, the beginning of the lease, and each quarter (December 31, March 31, and June 30) through June 30, 2021 (three-year lease term). The florist had the option to purchase the truck on September 29, 2020, for $10,000 when it was expected to have a residual value of $17,500. The estimated useful life of the truck is four years. Mid-South Auto Leasing’s quarterly interest rate for determining payments was 2% (approximately 8% annually). Mid-South paid $40,000 for the truck. Both companies use straight-line depreciation or amortization. Anything Grows’ incremental interest rate is 8%.

Hint: A lease term ends for accounting purposes when an option becomes exercisable if it’s expected to be exercised (i.e., a BPO). (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. Calculate the amount of selling profit that Mid-South would recognize in this sales-type lease. (Be careful to note that, although payments occur on the last calendar day of each quarter, since the first payment was at the beginning of the lease, payments represent an annuity due.)
2. Prepare the appropriate entries for Anything Grows and Mid-South on September 30, 2018.
3. Prepare an amortization schedule(s) describing the pattern of interest expense for Anything Grows and interest revenue for Mid-South Auto Leasing over the lease term.
4. Prepare the appropriate entries for Anything Grows and Mid-South Auto Leasing on December 31, 2018.
5. Prepare the appropriate entries for Anything Grows and Mid-South on September 29, 2020, assuming the purchase option was exercised on that date.

Answer 1

Part 1

Amount to be recovered through quarterly lease payments (5000*7.47199)	37360
Present value of the BPO price (10000*0.85349)	8535
Fair value	45895
Carrying value	40000
Selling profit	$5895

present value of $1: n=8, i=2% = 0.85349

present value of an annuity due of $1: n=8, i = 2% = 7.47199

Part 2

Anything Grows (Lessee)

Date	Account titles and explanation	Debit	Credit
September 30, 2018	Leased equipment	45895
	Lease payable		45895
September 30, 2018	Lease payable	5000
	Cash		5000

Mid-South Auto Leasing (Lessor)

Date	Account titles and explanation	Debit	Credit
September 30, 2018	Lease receivable	45895
	Cost of goods sold	40000
	Sales revenue		45895
	Inventory of equipment		40000
September 30, 2018	Cash	5000
	Lease receivable		5000

Part 3

date	payments	Effective interest (2%)	Decrease in balance	Outstanding balance
9/30/2018				45895
9/30/2018	5000		5000	40895
12/31/2018	5000	818	4182	36713
3/31/2019	5000	734	4266	32447
6/30/2019	5000	649	4351	28096
9/30/2019	5000	562	4438	23658
12/31/2019	5000	473	4527	19131
3/31/2020	5000	383	4617	14514
6/30/2020	5000	290	4710	9804
9/30/2020	10000	196	9804	0
	50000	4105	45895

Part 4

Anything Grows (Lessee)

Date	Account titles and explanation	Debit	Credit
December 31, 2018	Depreciation expense (45895/4)*1/4	2868
	Accumulated depreciation		2868
December 31, 2018	Interest expense	4182
	Lease payable		818
	Cash		5000

Mid-South Auto Leasing (Lessor)

Date	Account titles and explanation	Debit	Credit
December 31, 2018	Cash	5000
	Lease receivable		818
	Interest revenue		4182

Part 5

Anything Grows (Lessee)

Date	Account titles and explanation	Debit	Credit
December 31, 2020	Depreciation expense (45895/4)*3/4	8605
	Accumulated depreciation		8605
December 31, 2020	Interest expense	9804
	Lease payable	196
	Cash		10000

Mid-South Auto Leasing (Lessor)

Date	Account titles and explanation	Debit	Credit
December 31, 2020	Cash	10000
	Lease receivable		9804
	Interest revenue		196