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Aztec Corp. is a manufacturer of truck trailers. On April 1, 2020, Aztec Corp. leases ten trailers to Wildcat Company under a six-year noncancelable lease agreement. The following information about the lease and the trailers is provided: 1. Equal annual payments that are due starting on April 1, 2020 provide Aztec Corp. with an 8% return on net investment, unknown to Wildcat Company. 2. Titles to the trailers pass to Wildcat at the end of the lease. 3. The fair value of each trailer is $65,000. The cost of each trailer to Aztec Corp. is $45,000. Each trailer has an expected useful life of nine years. 4. Wildcat’s borrowing rate is 11% Instructions (a) Calculate the annual lease payment. (Round to nearest dollar.) (b) Prepare the journal entries for both the lessee and lessor for 2020 to record the lease agreement and the year-end entries. Round all amounts to the nearest dollar.

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Answer:

a. The annual lease payment would be $90,131

b.                                                      Dr.           Cr.

In Books of Lessor  

1 Jan,2017

Lease Receivable                    $650,000  

Cost of goods sold                 $450,000  

                        To sales revenue  $650,000

                           To Inventory  $450,000

31 Dec,2017

Cash                                     $90,131

  To Lease Receivable            $38,131

         To interest revenue            $51,869

In Books of Lessee  

1 Jan,2017

Purchase $650,000

To Lease payable  $650,000

31 Dec,2017

Interest expense $51,869

Lease payable $38,131

To cash  $90,000

Explanation:

a. To calculate the annual lease payment we woud have to use the following formula:

Annual lease payment = [Fair value of each trailer * Number of trailer given in lease] / PVAF(8%,6 years)

Present Value Factor

0 1.000000

1 0.925926

2 0.857339

3 0.793832

4 0.735030

5 0.680583

Total 4.992710

Cost of each Tractor= $45,000

No. of Tractor=10

Therefore, Total Cost=45,000 ×10= $450,000

Therefore, annual lease payment=$450,00/4.992710

annual lease payment=$90,131

b. The journal entries for both the lessee and lessor for 2020 to record the lease agreement and the year-end entries would be as follows:

                                                     Dr.           Cr.

In Books of Lessor  

1 Jan,2017

Lease Receivable                    $650,000  

Cost of goods sold                 $450,000  

                        To sales revenue  $650,000

                           To Inventory  $450,000

31 Dec,2017

Cash                                     $90,131

  To Lease Receivable            $38,131

         To interest revenue            $51,869

In Books of Lessee  

1 Jan,2017

Purchase $650,000

To Lease payable  $650,000

31 Dec,2017

Interest expense $51,869

Lease payable $38,131

To cash  $90,000

Lease Amortisation Schedule

Interest on Lease Receivable 31 December=8%*650,000= $52,000

Annual lease Rental=$90,131

Receivable Recovery=$90,131-$52,000=$38,131

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