Question

3. On January 1, 2019, B enters into a 3-year non-cancelable lease agreement for an asset with an 8-year useful life. The lease requires annual payments of $20,000 on January 15 of each year. At the end of the lease term, B has the option to purchase the asset for the bargain purchase price of $33,660 and it is reasonably assured that B will exercise the option. B's incremental borrowing rate is 10%. Relevant present value factors are as follows: PV for ordinary annuity, 3 periods, 10% 2.48685 PV for annuity due, 3 periods, 10% 2.73554 PV for single sum, 3 periods, 10% 0.75132 INSTRUCTIONS: a. Determine whether the lease is a finance lease or an operating lease and explain why you have made that determination. b. Prepare the journal entry for the signing of the lease on January 1, 2019. c. Prepare the journal entry for the first payment on 1/1/19. d. Prepare the journal entries required on December 31, 2013. e. Prepare the journal entry for the second payment on 1/1/20. 4. On January 1, 2019, B enters into a 3-vear non-cancelable lease agreement for an asset with a 4-year useful life The lease requires annual payments of $20,000 on December 31st of each year. At the end of the lease term, the asset will revert back to the lessor. B's incremental borrowing rate is 10% Relevant present value factors are as follows: PV for ordinary annuity, 3 periods, 10% 2.48685 PV for annuity due, 3 periods, 10% 2.73554 INSTRUCTIONS: a. Determine whether the lease is a finance lease or an operating lease and explain why you have made that determination. b. Prepare the journal entry for the signing of the lease on January 1, 2019 c. Prepare the required journal entries on December 31, 2019. 5. On January 1, 2019, B enters into a 4-year non-cancelable lease agreement for an asset with a 9-year useful life. The lease requires annual payments of $30,000 on December 31st of each year. B's incremental borrowing rate is 5%. Relevant present value factors are as follows: PV for ordinary annuity, 4 periods, 5% 3.54595 PV for annuity due, 4 periods, 5% 3.72325 INSTRUCTIONS: a. Determine whether the lease is a finance lease or an operating lease and explain why you have made that determination. b. Prepare the journal entry for the signing of the lease on January 1, 2019. c. Prepare the journal entry for the first payment on 12/31/19.

Answer 1

Ans. (a) :-

• Here, the lease is Finance lease.
• The lessee has the option of Bargain purchase at the end of the lease period, which is one of the criteria mentioned in US GAAP to be qualify as Finance lease. Hence, it would constitute a Finance lease.

Ans. (b) :- On signing of Lease[01.01.2019] :-

• On signing the lease, Fair value of the asset on lease shall be recorded in the books of Lessee i.e B in this case.
• Fair value refers to the Present Value (PV) of the total lease payments.
• PV = Annual lease payments * PV annuity factor for 3 years @10%

= $20,000 * 2.48685

= $ 49,737

• Journal Entry :-

01.01.2019 Leased asset a/c Dr. $49,737 -

To Lease liability a/c - $49,737

(being fair value of lease recognized in the books)

Ans. (c) :- On first Payment on 01.01.2019 :-

• Annual lease payment = $20,000 , which consist payment towards interest as well as liability.
• However, as the first payment is made on the very first day of the lease, there would not be any accrued interest and hence, for the first lease payment, entire amount would be applied towards Lease liability.

• Journal Entry :-

01.01.2019 Lease liability a/c Dr. $20,000 -

To Cash/bank a/c - $20,000

(being first lease payment made)

Ans. (d) :-On December 31, 2019 :-

• On December 31,2019 i.e on the year end, we shall pass a journal entry to recognize the accrued interest and book the interest expense.
• Outstanding balance of the liability portion during the year was $49,737 - $20,000 = $29,737 . Hence, interest expense would be 10% of $29,737 = $2973.7

Finance Expense a/c Dr. $2973.7 -

To Accrued interest / interest payable - $2973.7

(being interest expense and accrued interest booked for the year)

(Note :- As HOMEWORKLIB answering guidelines, I have answered first 4 sub questions as there are multiple questions in the image.)