Question

Wigan Cars issues an $17,00,000, 9%, 15-year mortgage note on December 31, 2010, to help finance a plant expansion program. The terms provide for 3-annual installment payments, not including real estate taxes and insurance of $65,000. Payments are due April 30, August 31 and December 31. 10 Instructions a. Prepare an installment payments schedule for the first 3 years. b. Prepare the entries for (1) the mortgage loan and (2) the first two installment payments. c. Show how the total mortgage liability should be reported on the balance sheet at December 31, 2011.

Answer 1

In this case, the sale and leaseback transaction is considered a financing transaction because the sales price is below the fair value of the asset.

As a result, the seller-lessee will recognize a gain on the sale of the asset. The gain will be calculated as follows:

```

Gain = Fair value of asset - Carrying amount of asset

= $4,500,000 - $3,600,000

= $900,000

```

The seller-lessee will also record a liability for the lease payments. The liability will be calculated as follows:

```

Lease liability = Present value of lease payments

= Annual rent * PV of ordinary annuity of 1 at 10% for 4 years

= $500,000 * 3.17

= $1,585,000

```

The seller-lessee will then record the following journal entries:

```

Dr. Cash 4,250,000

Dr. Gain on sale of asset 900,000

Cr. Equipment 3,600,000

Cr. Lease liability 1,585,000

```

The seller-lessee will then make lease payments of $500,000 each year for the next 4 years. The lease payments will be deducted from income on the income statement.

It is important to note that the sale and leaseback transaction in this case is a financing transaction and not a true sale. As a result, the seller-lessee will continue to be the owner of the asset and will be responsible for its depreciation and maintenance.