Question

Question: Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery 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 $100,000. Jensen depreciates all of its 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 reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

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

Short answer

Answer

Annual rental payment is $121,130

Step-by-step solution

Meaning of Rental payment

Rental payment isa payment made by one tenant in exchange for the rightto occupy or use another's property at predetermined intervals, usually in an amount established by contract.

Calculation of annual rental payments

$$\begin{gathered} \text{Annual}\text{rental}\text{payments =}\frac{\text{Fair}\text{value}\text{of}\text{asset -}\left(Residualvalue\times Presentvalue\right)}{\text{Present}\text{value}\text{ofannuity}} \\ \text{=}\frac{\$700,000-\left(\$100,000\times 0.51316\right)}{5.35526} \\ =\frac{\$700,000-\$51,316}{5.35526} \\ =\$121,130 \end{gathered}$$

Note: Present value of $1 at 10% for 7 periods

Present value of an annuity due at 10% for 7 periods