Nelson Ltd manufactures specialised machinery for both sale and lease. On 1 July 2016, Nelson leased a machine to Poggi Ltd. The machine cost Nelson Ltd €195 000 to manufacture, and its fair value at the inception of the lease was €212 515. The interest rate implicit in the lease is 10%, which is in line with current market rates. Under the terms of the lease, Poggi Ltd has guaranteed €25 000 of the asset's expected residual value of €37 000 at the end of the 5-year lease term. The debit to the sales revenue account in Nelson's books is:

Question

Quizplus · Accepted Answer

The debit to sales revenue account is the present value of the lease payments, which can be calculated using the interest rate implicit in the lease. The guaranteed residual value is not included in the calculation of the lease payments. Using the formula for present value of an annuity, the present value of lease payments is:

PV = (lease payment) x [1 - (1 / (1 + i)n)] / i

Where i is the interest rate implicit in the lease (10%), n is the number of lease payments (5), and lease payment is the annual rental payment.

Annual rental payment = (fair value - guaranteed residual value) / present value factor

Present value factor = [1 - (1 / (1 + i)n)] / i + (guaranteed residual value / (1 + i)n)

Present value factor = [1 - (1 / (1 + 0.1)5)] / 0.1 + (25,000 / (1 + 0.1)5) = 3.79079

Annual rental payment = (212,515 - 25,000) / 3.79079 = 52,568.32

PV = 52,568.32 x [1 - (1 / (1 + 0.1)5)] / 0.1 = 205,063.05

Therefore, the debit to sales revenue account is €205,063.

Nelson Ltd Manufactures Specialised Machinery for Both Sale and Lease