Question

(Lessor Computations and Entries, Sales-Type Lease with Unguaranteed Residual Value) George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is \(278,072, and its unguaranteed residual value at the end of the lease term is estimated to be \)20,000. National will pay annual payments of \(40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of \)180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessor and compute the amount of each of the following items.

1. Lease receivable.

Short answer

The lease is a sale-type lease.

Step-by-step solution

Meaning of Lease Receivable

Any rents, payments, and other amounts (including, without limitation, any sales or use taxes, supplementary rent payments, additional rent payments, rental stores, engine stores, maintenance stores, and maintenance) under or in connection with the lease are known as a lease receivable.

Explaining the nature of the lease in relation to the lessor

The lease is a sales-type lease because:

1) The lease period exceeds 75% of the asset's expected economic life

(10/12 = 83%),

2) Payment collectability is fairly ensured, and no further expenditures are paid, and

3) George Company made a profit in addition to the financing fee.

Computing amount of lease receivable

Present value of an annuity due of $1 for 10 periods discounted at 10%	6.75902
Annual lease payment	$40,000
Present value of the 10 rental payments	270,361
Add the present value of the estimated residual value of $20,000 in 10 years at 10% ($20,000 X .38554)	7,711
Lease receivable at inception	$278,072