Question P21-6 (Lessee-Lessor Entries, Finance Lease with a Guaranteed Residual Value) (LO 2, 4) Glaus Leasing Company agrees to lease equipment to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement. 1.The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.

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P21-6 (Lessee-Lessor Entries, Finance Lease with a Guaranteed Residual Value) (LO 2, 4) Glaus Leasing Company agrees to lease equipment to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement. 1.The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2.The cost of the machinery is $525,000, and the fair value of the asset on January 1, 2017, is $700,000. 3.At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $50,000. Jensen estimates that the expected residual value at the end of the lease term will be $50,000. Jensen amortizes all of its leased equipment on a straight-line basis. 4.The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 5.The collectibility of the lease payments is probable. 6.Glaus desires a 5% rate of return on its investments. Jensen's incremental borrowing rate is 6%, and the lessor's implicit rate is unknown. Instructions (Assume the accounting period ends on December 31.)

(a) Discuss the nature of this lease for both the lessee and the lessor.

(b) Calculate the amount of the annual rental payment required.

(d) Prepare the journal entries Jensen would make in 2017 and 2018 related to the lease arrangement.

(e) Prepare the journal entries Glaus would make in 2017 and 2018 related to the lease arrangement.

(f) Suppose Jensen expects the residual value at the end of the lease term to be $40,000 but still guarantees a residual of $50,000. Compute the value of the lease liability at lease commencement.

Transcribed Image Text: P21-6 (Lessee-Lessor Entries, Finance Lease with a Guaranteed Residual Value) (LO 2, 4) Glaus Leasing Company agrees to lease equipment to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement. 1.The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.

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 Glaus Leasing Company               a)This lease is a capital lease to Jenson becauselease term is greater than 75% of economics life of the leasedassets. Lease Term7Years     Economic life9Years     Lease Ternm=(7/9)*10078%      This lease is a capital lease to Glause leasebecause     1)Collectibility of lease payment is reasonablypredictable.     2)Lease term is > 75% of economic life              b)Annual Rental=($700000-$50000*.711)/5.786 $       1,14,838              Present Value of $1 at 5% for 7 years0.711      Present Value of annuity at 5% for 7 years5.786             c)Present Value of minimum lease payment       P.V of annual payment=($114837*5.786) $       6,41,023      P.V of Residual payment=($50000*.705) $          35,250      Total $       6,76,273                      Present Value of $1 at 6% for 7 years0.705      Present Value of annuity at 6% for 7 years5.582             d)Journal Entries      DateParticularAmt (Dr)Amt (Cr)    01-01-2017Lease Equipment $       6,76,273          To Lease Liability  $       6,76,273     (Being amount of lease payment)              01-01-2017Lease liability $       1,14,838          To Cash  $       1,14,838     (Being amount of lease               31-12-2017Depreciation Expense          To AccumulatedDepreciation($676273-$5000)/7 $          89,468         $          89,468            31-12-2017Interest Expense $          61,758         To Interest Payable($676273-$114837))*6%  $          61,758            01-01-2018Lease liability $          53,080      Interest Payable $          61,758           To Cash  $       1,14,838     (Being amount of lease liability)      31-12-2018Depreciation Expense $          89,468          To Accumulated Depreciation  $          89,468     (Being amount of Depreciation)              31-12-2018Interest Expense $          30,501         To InterestPayable($676273-$114837-$53079.62))*6%  $          30,501             In the books of Glause       DateParticular Amt (Dr)  Amt (Cr)     01-01-2017Lease Receivable $       7,00,000      Cost of goods sold $       5,25,000          To Sales Revenue  $       7,00,000          To Inventory  $       5,25,000     (Being amount of sale of Machinery)      01-01-2017Cash $       1,14,838           To Lease Receivable  $       1,14,838     (Being amount received for lease payment)              31-12-2017Interest Receivable $          29,258           To InterestRevenue($700000-$114837)*5%  $          29,258                    01-01-2018Cash $       1,14,838           To Lease Receivable  $          85,579          To Interest Receivable  $          29,258     (Being amount of Cash received for leasepayment and interest)              31-12-2018Interest Receivable $          24,979           To InterestRevenue($700000-$114837-$85579)*5%  $          24,979     (Being amount of Interest Receivable)                       ...