Question

Sharke Inc. was incorporated in 2017 to operate as a computer software service firm with an accounting fiscal year ending July 31. Sharke's primary product is an on-line inventory-control system; its customers pay a fixed fee plus usage charges for using the system.  

On August 1, 2018, Sharke leased a large computer system from the manufacturer. The lease terms are shown below:

Annual lease payment

$ 20,711.11

paid at the beginning of the year

Date of first payment

Aug. 1, 2018

Lease term

5

years from date of first payment

Implied interest rate in the contract

4%

Depreciation method

Straight-line

Residual value at the end of the lease

$         5,000.00

guaranteed by Sharke

This lease is to be accounted for as a finance lease. Following is a schedule of the present value of $1 for selected periods discounted a specific interest rate when payments are made at the beginning of each period.

					8%	4%
	Present value of Annuity Due for 5yrs.				4.31213	4.62990
	Present value of $1 for 5 yrs.				0.68058	0.82193
Required:
1.	Identify the criteria for determining finance leases.
2.	Prepare an amortization schedule for this lease agreement
3.	Prepare, in general journal form, all entries Sharke should make in its accounting records for the first two fiscal years relating to this lease

Answer 1

1. Criteria for determining finance leases :-

The ownership of the asset is tranaferred from the lessor to he lessee at the end of the lease period

The lessee can buy the asset from the lessor at a price below the market price at the end of the lease term.

The period of the lease is for atleast 75% of the useful life of the assets

The present value of the minimum lease payments is atleast 90% of the fair value of the asset at the inception of the lease.

2. Amortization schedule for lease payment