Question

E21.17 (LO 3,4) (Accounting for an Operating Lease) On January 1, 2020, Nelson Co. leased a building to Wise Inc. The relevant information related to the lease is as follows. 1. The lease arrangement is for 10 years. The building is expected to have a residual value at the end of the lease of $3,500,000 (unguaranteed). 2. The leased building has a cost of $4,000,000 and was purchased for cash on January 1, 2020. 3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value. 4. Lease payments are $275,000 per year and are made at the beginning of the year. 5. Wise has an incremental borrowing rate of 8%, and the rate implicit in the lease is unknown to Wise. 6. Both the lessor and the lessee are on a calendar-year basis. Instructions a. Prepare the journal entries that Nelson should make in 2020. b. Prepare the journal entries that Wise should make in 2020. c. If Wise paid $30,000 to a real estate broker on January 1, 2020, as a fee for finding the lessor, what is the initial measurement of the right-of-use asset? Explain.

Answer 1

Answer :-

a) Journal entries that Nelson should make in 2020 are as follows :-

Date	Particular	Debit	Credit
1/1/2020	Building A/c Dr.	$4,000,000
	To Cash A/c		$4,000,000
	(To record the lease building Cost on January 1,2020)
31/12/2020	Cash A/c Dr.	$275,000
	To Rent Revenue A/c		$275,000
	(To record Lease payment)
	Deprecation expense A/c. Dr.	$80,000
	To Accumulated Building depreciation A/c		$80,000
	(To record Deprecation expense)
	Note - Deprecation expense = Cost of Building/Economic life of Building = $4,000,000/50 = $80,000

b) Journal entries that Wise should make in 2020 is as follows :-

Date	Particular	Debit	Credit
31.12.2020	Rent Expense A/c Dr.	$275,000
	To Cash A/c		$275,000
	(To record rent Expense)

c)First we find PV of rental payments

Lease payment is $275,000 at the beginning of the year.

Incremental borrowing rate is 8%

Right of use Asset = PV of rental payment = $275,000 × 7.2469

Right of use Asset =  $1,992,894

initial measurement is/would be = (1,992,894 + 30,000) = $2,022,894