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.

(3) Cost of sales.

Short answer

Cost of sales is $172,289.

Step-by-step solution

Meaning of Cost of Sales

Cost of sales can be referred to as the total amount that a retailer or wholesaler incurs to purchase a particular item. On the income statement, the cost of sales is shown as a direct cost.

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.

Computation of cost of sales

The cost of sales is $172,289 (the asset's $180,000 cost is less than the present value of the $7,711 unguaranteed residual value).

$\begin{array}{rcl}\text{Cost}\text{of}\text{sales}& =& \text{Assets}\text{vale}-\text{Unguaranteed}\text{residual}\text{value}\\ & =& \$180,000-\$7,711\\ & =& \$172,289\end{array}$