Turpin Corp., which uses private enterprise GAAP, leases a car to Jaimme DeLory on June 1, 2011. The term of the non-cancellable lease is 48 months. The following information is provided about the lease:
1. The lessee is given an option to purchase the automobile at the end of the lease term for $5,000.
2. The automobile’s fair value on June 1, 2011, is $29,500. It is carried in Turpin’s inventory at $21,200.
3. The car has an economic life of seven years, with a $1,000 residual value at the end of that time. The car’s estimated fair value is $10,000 after four years, $7,000 after five years, and $2,500 after six years.
4. Turpin wants to earn a 12% rate of return (1% per month) on any financing transactions.
5. Jaimme DeLory represents a reasonable credit risk and no future costs are anticipated in relation to this lease.
6. The lease agreement calls for a $1,000 down payment on June 1, 2011, and 48 equal monthly payments on the first of each month, beginning June 1, 2011.
Instructions
(a) Determine the amount of the monthly lease payment using present value tables, a financial calculator, or computer spreadsheet functions.
(b) What type of lease is this to Turpin Corp.? Explain.
(c) Prepare a lease amortization schedule for the 48-month lease term using a computer spreadsheet.
(d) Prepare the entries that are required, if any, on December 31, 2011, Turpin’s fiscal year end.
(e) How much income will Turpin report on its 2011 income statement relative to this lease?
(f) What is the net investment in the lease to be reported on the December 31, 2011 statement of financial position?
How much is reported in current assets? In non-current assets?
(a)
The lessor sets the annual rental payment as follows:
Fair market value of leased asset to lessor $28,500.00*
Less: Present value of bargain purchase
option $5,000 X .62026
(present value of 1 at 1% for 48 periods) 3,101.30
Amount to be recovered through lease payments $25,398.70
Forty-eight periodic lease payments
$25,398.70 ÷ 38.3538** $662.22
* Fair value of $29,500.00 less down payment of $1,000.00
**Present value of annuity due of 1 for 48 periods at 1%.
| Excel formula =PMT(rate,nper,pv,fv,type) |
| Using a financial calculator: | ||
| PV | $ (28,500) | |
| I | 1% | |
| N | 48 | |
| PMT | $ ? | Yields $662.22 |
| FV | $ 5,000 | |
| Type | 1 | |
(b)
The lease agreement has a bargain purchase option. The lease, therefore, qualifies as a capital lease from the viewpoint of the lessee. The collectability of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. Due to the fact that the initial amount of net investment (which in this case equals the present value of the minimum lease payments, ($28,500 + the down payment of $1,000) exceeds the lessor’s cost ($21,200), the lease is a sales-type lease to the lessor.
(c)
Turpin Corp. (Lessor)
Lease Amortization Schedule
| Month | | Annual Lease Payment Plus RV | | Interest (1%) on Net Investment | | Net Investment Recovery | | Balance of Net Investment | |||||||||
| | | | | | | | | $28,500.00 | |||||||||
| 1 | | $662.22 | | | | $662.22 | | 27,837.78 | |||||||||
| 2 | | 662.22 | | $278.38 | | 383.84 | | 27,453.94 | |||||||||
| 3 | | 662.22 | | 274.54 | | 387.68 | | 27,066.26 | |||||||||
| 4 | | 662.22 | | 270.66 | | 391.56 | | 26,674.70 | |||||||||
| 5 | | 662.22 | | 266.75 | | 395.47 | | 26,279.23 | |||||||||
| 6 | | 662.22 | | 262.79 | | 399.43 | | 25,879.80 | |||||||||
| 7 | | 662.22 | | 258.80 | | 403.42 | | 25,476.38 | |||||||||
| 8 | | 662.22 | | 254.76 | | 407.46 | | 25,068.92 | |||||||||
| 9 | | 662.22 | | 250.69 | | 411.53 | | 24,657.39 | |||||||||
| 10 | | 662.22 | | 246.57 | | 415.65 | | 24,241.74 | |||||||||
| 11 | | 662.22 | | 242.42 | | 419.80 | | 23,821.94 | |||||||||
| 12 | | 662.22 | | 238.22 | | 424.00 | | 23,397.94 | |||||||||
| 13 | | 662.22 | | 233.98 | | 428.24 | | 22,969.70 | |||||||||
| 14 | | 662.22 | | 229.70 | | 432.52 | | 22,537.18 | |||||||||
| 15 | | 662.22 | | 225.37 | | 436.85 | | 22,100.33 | |||||||||
| 16 | | 662.22 | | 221.00 | | 441.22 | | 21,659.11 | |||||||||
| 17 | | 662.22 | | 216.59 | | 445.63 | | 21,213.48 | |||||||||
| 18 | | 662.22 | | 212.13 | | 450.09 | | 20,763.40 | |||||||||
| 19 | | 662.22 | | 207.63 | | 454.59 | | 20,308.81 | |||||||||
| 20 | | 662.22 | | 203.09 | | 459.13 | | 19,849.68 | |||||||||
| 21 | | 662.22 | | 198.50 | | 463.72 | | 19,385.96 | |||||||||
| 22 | | 662.22 | | 193.86 | | 468.36 | | 18,917.60 | |||||||||
| 23 | | 662.22 | | 189.18 | | 473.04 | | 18,444.55 | |||||||||
| Month | | Annual Lease Payment Plus RV | | Interest (1%) on Net Investment | | Net Investment Recovery | | Balance of Net Investment | ||||||
| 24 | | 662.22 | | 184.45 | | 477.77 | | 17,966.78 | ||||||
| 25 | | 662.22 | | 179.67 | | 482.55 | | 17,484.23 | ||||||
| 26 | | 662.22 | | 174.84 | | 487.38 | | 16,996.85 | ||||||
| 27 | | 662.22 | | 169.97 | | 492.25 | | 16,504.60 | ||||||
| 28 | | 662.22 | | 165.05 | | 497.17 | | 16,007.42 | ||||||
| 29 | | 662.22 | | 160.07 | | 502.15 | | 15,505.28 | ||||||
| 30 | | 662.22 | | 155.05 | | 507.17 | | 14,998.11 | ||||||
| 31 | | 662.22 | | 149.98 | | 512.24 | | 14,485.87 | ||||||
| 32 | | 662.22 | | 144.86 | | 517.36 | | 13,968.51 | ||||||
| 33 | | 662.22 | | 139.69 | | 522.53 | | 13,445.97 | ||||||
| 34 | | 662.22 | | 134.46 | | 527.76 | | 12,918.21 | ||||||
| 35 | | 662.22 | | 129.18 | | 533.04 | | 12,385.18 | ||||||
| 36 | | 662.22 | | 123.85 | | 538.37 | | 11,846.81 | ||||||
| 37 | | 662.22 | | 118.47 | | 543.75 | | 11,303.06 | ||||||
| 38 | | 662.22 | | 113.03 | | 549.19 | | 10,753.87 | ||||||
| 39 | | 662.22 | | 107.54 | | 554.68 | | 10,199.19 | ||||||
| 40 | | 662.22 | | 101.99 | | 560.23 | | 9,638.96 | ||||||
| 41 | | 662.22 | | 96.39 | | 565.83 | | 9,073.13 | ||||||
| 42 | | 662.22 | | 90.73 | | 571.49 | | 8,501.64 | ||||||
| 43 | | 662.22 | | 85.02 | | 577.20 | | 7,924.43 | ||||||
| 44 | | 662.22 | | 79.24 | | 582.98 | | 7,341.46 | ||||||
| 45 | | 662.22 | | 73.41 | | 588.81 | | 6,752.65 | ||||||
| 46 | | 662.22 | | 67.53 | | 594.69 | | 6,157.96 | ||||||
| 47 | | 662.22 | | 61.58 | | 600.64 | | 5,557.32 | ||||||
| 48 | | 662.22 | | 55.57 | | 606.65 | | 4,950.67 | ||||||
| | | 5,000.00 | | 49.33 * | | 4,950.67 | | - | ||||||
| | | | | $8,286.56 | | $28,500.00 | | | ||||||
* rounding by $.18
(d) A journal entry would be required on December 31, 2011 by Turpin Corp. to accrue the interest in the amount of $254.76 related to payment no. 8, which is due January 1, 2012.
Unearned Interest Income—Leases ... 254.76
Interest Income—Leases ......... 254.76
(c) The income to be reported on the income statement of Turpin Corp. for the fiscal year ending December 31, 2011 concerning this lease will be as follows:
Sales $29,500
Cost of goods sold 21,200
Gross profit 8,300
Interest income - lease 1,867
(Interest income represents the sum of the interest for the first 7 payments from the table above and an accrual of interest for the 8th payment)
(d) At December 31, 2011, the balance sheet would have reported as a current asset, the amount of the principal reduction that will be obtained in the next twelve months. Based on the table above the sum of the principal reduction for monthly payment 8 through 19 total $5,168. The remaining amount of the balance of the investment at December 31, 2011 ($25,476 less the current portion of $5,168) of $20,308 will be reported as a long-term lease payment receivable.
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