[jorden_rowrow]

Becker Question –

Peg Co. leased equipment from Howe Corp. on July 1, Year 1 for an eight-year period expiring June 30, Year 9. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, Year 1. The rate of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe’s accounting records is $2,800,000. The lease is appropriately recorded as a sales-type (finance) lease. What is the amount of profit on the sale and interest revenue that Howe should record for the year ended December 31, Year 1?

Here’s the example and the answer is 720000 for profit and 146000 for interest rev. I understand how they got that but I have a question regarding the profit. Why don’t you take a portion of upto the giveback which is normally the present value. Isn’t 600,000/3,520,000 greater than 10 percent. If that’s the case then you should defer a portion of the gain and not all

[jorden_rowrow]

I do have a train of thought that might work, does the 600,000 represent pv of lease rentals?

[OnOurWayToCPA]

Jorden_rowrow:

The reason you don't defer any gain is because this is a sales type finance lease, not a sale leaseback transaction.

You have the sale leaseback rules correct (defering up to what you give back, etc.) but are applying them to the wrong transaction.

The gain is 720,000 because the sale is a true sale to the lessor and is computed as the difference between the sales price (3,520,000) and net book value of 2,800,000.

[jorden_rowrow]

how can you tell if its a lease back or a sales type

[OnOurWayToCPA]

jorden_rowrow:

The question doesn't mention anything about the transaction being a sale leaseback transaction.

Its a sales type lease b/c it says so.

It sounds like you are over thinking the problem.

[Author]

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