CHL Corporation manufactures specialty equipment with an estimated economic life of 12 years and leases it to Provincial Airlines Corp. for a period of 10 years. Both CHL and Provincial Airlines follow private enterprise GAAP. The equipment’s normal selling price is $210,482 and its unguaranteed residual value at the end of the lease term is estimated to be $15,000. Provincial Airlines will pay annual payments of $25,000 at the beginning of each year and all maintenance, insurance, and taxes. CHL incurred costs of $105,000 in manufacturing the equipment and $7,000 in negotiating and closing the lease. CHL 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 8%.
Instructions
Answer the following questions, rounding all numbers to the nearest dollar.
(a) Discuss the nature of this lease in relation to the lessor and calculate the amount of each of the following items:
1. Gross investment
2. Unearned interest income
3. Sales price
4. Cost of sales
(b) Prepare a 10-year lease amortization schedule for the lease obligation using a computer spreadsheet.
(c) Prepare all of the lessor’s journal entries for the first year of the lease, assuming the lessor’s fiscal year end is five months into the lease. Reversing entries are not used.
(d) Determine the current and non-current portion of the net investment at the lessor’s fiscal year end, which is five months into the lease.
(e) Assuming that the $15,000 residual value is guaranteed by the lessee, what changes are necessary to parts (a) to (d)?