Accounting problem on lease payment: Question

Aquarius Incorporated (AI) uses leases as a method of selling its products. In early 2011, AI completed construction of a passenger ferry for use between Manhattan and Staten Island. On April 1, 2011, the ferry was leased to the Manhattan Ferry Line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. Annual lease payments do not include executory costs. Other terms of the agreement are as follows:

Original Cost of the ferry Fair Value of ferry at the lease date Lease Payments (paid in advance) Estimated residual value (unguaranteed) Incremental borrowing rate - lessee Date of first lease payment Lease period

$1,500,000 $2,107,102 $225,000 $78,000 $10% April 1, 2011 20 years

Required:

(a) Compute the amount of financial revenue that will be earned over the lease term and the manufacturers profit that
will be earned immediately by Aquarius. (11 points)

(b) Give the entry to record the signing of the lease on Aquarius books. (c) Compute the implicit rate of interest on the lease.

(8 points)

(5 points)

(d) Give the journal entries necessary on Aquarius books to record the lease for the first three years, exclusive of the
initial entry. Aquarius has a calendar accounting year.
(39 points)

(e) Indicate the balance of Lease Payments Receivable at December 31, 2013.
(12 points)

Solution:
Q1 AQUARIUS INCORPORATED: 4,578,000 Gross investment PV of annuity due for 20 periods @ 10% Net Investment Unearned Interest revenue Cost of sales 9.36492 2,118,701 2,459,299 1,488,406 (PV of lease payments + PV of residual value) Gross imvestment - net investment) (cost - PV of residual value) (minimum lease payments + unguaranteed residual value)

LEASE AMORTIZATION TABLE

DATE

INTEREST

LEASE RENT

LEASE RENT - INTEREST

CARRYING VALUE 2,118,696

1/Apr/11 1/Apr/12 1/Apr/13 1/Apr/14 1/Apr/15 1/Apr/16 1/Apr/17 1/Apr/18 1/Apr/19 1/Apr/20 187,618 183,914 179,844 175,370 170,453 165,049 159,109 152,581 145,406

225000 225000 225000 225000 225000 225000 225000 225000 225000 225000 37,382 41,086 45,156 49,630 54,547 59,951 65,891 72,419 79,594

1,893,696 1,856,314 1,815,228 1,770,072 1,720,442 1,665,895 1,605,943 1,540,052 1,467,633 1,388,039

1/Apr/21 1/Apr/22 1/Apr/23 1/Apr/24 1/Apr/25 1/Apr/26 1/Apr/27 1/Apr/28 1/Apr/29 1/Apr/30

137,520 128,853 119,327 108,858 97,351 84,704 70,804 55,527 38,737 20,282

225000 225000 225000 225000 225000 225000 225000 225000 225000 225000

87,480 96,147 105,673 116,142 127,649 140,296 154,196 169,473 186,263 204,718

1,300,559 1,204,412 1,098,739 982,596 854,947 714,651 560,455 390,982 204,718 1

(a)

2,459,299 618,701

Financial profit earned Manufacturer's profit on sale

(b)
JOUIRNAL ENTRY: Lease payments receivable Cost of sales Sales Unearned Interest Cost of Ferry

DEBIT 4,578,000 1,488,406

CREDIT

2,107,107 2,459,299 1,500,000

(c )

The implicit rate of interest is approximately 10% (actually 9.9075%) since the table above shows that the fair value of the Ferry is reduced to zero at the end of 20 years when interest is charged at 10%.

(d)

DEBIT

CREDIT

31-Dec-11
Unearned Interest Interest revenue

142,027 142,027

1-Apr-12 Cash
Unearned Interest

225,000 45,591 47,053 225,000

Interest
Lease payments receivable

31-Dec-12
Unearned Interest Interest revenue

137,936 137,936

1-Apr-13 Cash
Unearned Interest

225,000 45,979 45,979 225,000

Interest
Lease payments receivable

31-Dec-13
Unearned Interest Interest revenue

134,883 134,883

1-Apr-14 Cash
Unearned Interest

225,000
44,961 44,961

Interest
Lease payments receivable

225,000

(e) Lease payments receivable at 31 dec 2013

3,903,000

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