Question

Question: (Lessee-Lessor Entries; Sales-Type Lease) On January 1, 2017, 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 2017.
3. The fair value of the equipment on January 1, 2017, is \(150,000, and its cost is \)120,000.
4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. 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

(Both the lessor and the lessee’s accounting period ends on December 31.)

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

Short answer

Answer

Rental Payments are $30,804.

Step-by-step solution

Meaning of Rental payments

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

Calculating the amount of the annual rental payment

Computation of annual rental payment

$$\begin{gathered} Rentalpayments=\frac{Fairvalueofequipment-(unguarenteedresidualvalue\times presentvalue)}{presentvalueofannuity} \\ =\frac{\$150,000\left(\$10,000\times 0.53464\right)}{4,69590} \\ =\frac{\$150,000-5,346.4}{4,69590} \\ =\$30,804 \end{gathered}$$

Note:

Present value of $1 at 11% for 6 periods

Present value of an annuity due at 11% for 6 periods.