On December 31, 2018, Rhone-Metro Industries leased equipment to Western Soya Co. for a four-year period ending December 31, 2022, at which time possession of the leased asset will revert back to Rhone-Metro. The equipment cost Rhone-Metro $347,516 and has an expected useful life of six years. Its normal sales price is $347,516. The lessee-guaranteed residual value at December 31, 2022, is $17,000. Equal payments under the lease are $95,000 and are due on December 31 of each year. The first payment was made on December 31, 2018. Western Soya’s incremental borrowing rate is 10%. Western Soya knows the interest rate implicit in the lease payments is 9%. 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 $95,000
annual lease payments.
2. How should this lease be classified (a) by
Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries
(the lessor)?
3. Prepare the appropriate entries for both
Western Soya Co. and Rhone-Metro on December 31, 2018.
4. Prepare an amortization schedule(s) describing
the pattern of interest over the lease term for the lessee and the
lessor.
5. Prepare all appropriate entries for both
Western Soya and Rhone-Metro on December 31, 2019 (the second lease
payment and depreciation).
6. Prepare the appropriate entries for both
Western Soya and Rhone-Metro on December 31, 2022 assuming the
equipment is returned to Rhone-Metro and the actual residual value
on that date is $2,000.
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Since Lessee borrowing rate 10% is higher than Lessor implicate rate of 9% which is known to Lessee, all calculation will be at 9%
1. Show how Rhone-Metro calculated the $95,000 annual lease payments.
| Fair Value/Sale Value | 347516 | |
| Less:Present Value of Guranteed Salvage | 17000*0.7084 (PV 9%, 4 Year) | 12043 |
| Total | 335473 | |
| Divided by PVAF 9%, 4 Year | 335473/3.531295 | 95000 |
| Annual Lease Payment | 95000 |
2. How should this lease be classified (a) by Western Soya Co. (the lessee) and (b) by Rhone-Metro Industries (the lessor)?
Since PV of Lease payment is equal to fair value (347516), this is Capital Lease for Lessee.
Also, lease payment are reasonably assured, and cost is equal to sale price, this is direct financing lease for lessor
3. Prepare the appropriate entries for both Western Soya Co. and Rhone-Metro on December 31, 2018.
| Date | Account | Debit | Credit |
| 3. Journal Entries-Lessee | |||
| 31-Dec-18 | Lease Equipment | 347516 | |
| Lease Payable | 347516 | ||
| 31-Dec-18 | Lease Payable | 95000 | |
| Cash | 95000 | ||
| 3. Journal Entries-Lessor | |||
| 31-Dec-18 | Lease receivable | 347516 | |
| Equipment | 347516 | ||
| 31-Dec-18 | Cash | 95000 | |
| Lease receivable | 95000 |
4. Prepare an amortization schedule(s) describing the pattern of interest over the lease term for the lessee and the lessor.
| Date | Payment | Interest 9% | Principal | Balance |
| 31-Dec-18 | 347516 | |||
| 31-Dec-18 | 95000 | 0 | 95000 | 252516 |
| 31-Dec-19 | 95000 | 22726 | 72274 | 180242 |
| 31-Dec-20 | 95000 | 16222 | 78778 | 101464 |
| 31-Dec-21 | 95000 | 9132 | 85868 | 15596 |
| 31-Dec-22 | 17000 | 1405 | 15595 | 0 |
5. Prepare all appropriate entries for both Western Soya and Rhone-Metro on December 31, 2019 (the second lease payment and depreciation).
| Date | Account | Debit | Credit |
| 5. Journal Entries-Lessee | |||
| 31-Dec-18 | Lease Payable | 72274 | |
| Interest Expense | 22726 | ||
| Cash | 95000 | ||
| 31-Dec-18 | Depreciation Expense | 82629 | |
| Accumulated Depreciation | 82629 | ||
| (347516-17000)/4 | |||
| 5. Journal Entries-Lessor | |||
| 31-Dec-18 | Cash | 95000 | |
| Interest Revenue | 22726 | ||
| Lease receivable | 72274 | ||
6. Prepare the appropriate entries for both Western Soya and Rhone-Metro on December 31, 2022 assuming the equipment is returned to Rhone-Metro and the actual residual value on that date is $2,000.
| Date | Account | Debit | Credit |
| 6. Journal Entries-Lessee | |||
| 31-Dec-22 | Lease Payable | 15595 | |
| Interest Expense | 1405 | ||
| Accumulated Dep (82629*4) | 330516 | ||
| Loss on residual value-guaranteed | 15000 | ||
| Lease Equipment | 347516 | ||
| Cash (17000-2000) | 15000 | ||
| 6. Journal Entries-Lessor | |||
| 31-Dec-22 | Cash | 15000 | |
| Equipment | 2000 | ||
| Interest Revenue | 1405 | ||
| Lease receivable | 15595 |
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