Lease entries and calculation
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Bensen and Flynn: Lessee-Lessor Entries
On January 1, 2008, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.
1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
2. Equal rental payments are due on January 1 of each year, beginning in 2008.
3. The fair value of the equipment on January 1, 2008, is $150,000, and its cost is $120,000.
4. The equipment has an economic life of 8 years. Flynn depreciates all of its equipment on a straight-line basis.
5. Bensen set the annual rental to ensure an 11% rate of return. Flynn's incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
INSTRUCTIONS:
a) Discuss the nature of this lease to Bensen and Flynn.
b) Calculate the amount of the annual rental payment.
c) Prepare all necessary journal entries for Flynn for 2008.
d) Prepare all the necessary journal entries for Bensen for 2008.
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Solution Summary
The solution explains how to identify the type of lease and make the related journal entries for lessee and lessor
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a) Discuss the nature of this lease to Bensen and Flynn.
For Flynn the lease will be a capital lease since the lease term is 6years/8 year life = 75% of the life and so qualifies for a capital lease.
For Bensen, the lessor, this is also a capital lease as collectability of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor. Also this will be a sales type lease as the fair value of equipment is greater than the cost and so there is an element of profit.
b) Calculate the amount of the annual rental payment.
Bensen will calculate the annual rental based on its rate of 11%. The annual payment would be annuity and would ...
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