On October 1, 2019, CGFEB Co. signed a lease with Tanner, Inc. for a piece of equipment

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Question:

On October 1, 2019, CGFEB Co. signed a lease with Tanner, Inc. for a piece of equipment that CGFEB Co. needs for a new production process. The lease is for 4 years with the first payment due at the time the lease is signed and the remaining payments due on September 30th each year thereafter. At the end of the lease, the equipment will be returned to Tanner, Inc.. In order to secure a slightly smaller lease payment, CGFEB Co. has guaranteed the estimated residual value of $20,000 at the end of the lease period.

At the time the lease was signed, the fair value of the equipment was $340,000, Tanner, Inc.'s normal selling price for the item. Tanner, Inc. spends only $156,000 producing the equipment, making it a big money maker for the company. Of course, the equipment is well made. Tanner, Inc. tells its customers that the machine should last for 4 years without any trouble (or any salvage value).

Tanner, Inc. used a 6% implicit rate to determine the lease payments for CGFEB Co. (a bit higher than normal, since the finance department considers CGFEB Co. a risky client). To avoid any political issues with its clients, Tanner, Inc. never released the implicit interest rate for any lease. CGFEB Co.’s incremental borrowing rate is 8%.

Tanner, Inc. spent $3,000 to initial the lease, while CGFEB Co. spent $4,800.

At the end of the lease term, the asset was worth only $12,000, so CGFEB Co. made up the difference in cash to meet their guarantee. Because of the unusual cash payment (most clients returned leased assets for more than the estimated residual value), CGFEB Co.'s auditors have insisted on doing additional testing on the transaction. As part of their testing, they have asked to see the entries from the last year of the lease along with the amortization schedule.

1.What is the amount of the lease payment?

2. How much interest will accrue over the life of the lease?

3. How much interest will the company recognize in final interest entry?

4. How much cash will the lessee need to pay at the end of the lease term?

5. What is the sum of the debits in the entry for the return of the leased asset?