Question

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 31" 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

Solution a:

Lease is to be classified as operating lease as lease period covered is less than 75% of useful life of asset. Further lease do not contain bargain purchase option and asset will be transferred to lessor at the end of lease period.

Solution b:

Present value of lease payments = $30,000 * Cumulative PV factor at 5% for 4 periods of ordinary annuity

= $30,000 * 3.54595 = $106,379

Journal Entries
Date	Particulars	Debit	Credit
1-Jan-19	Right of use assets Dr	$106,379.00
	To Lease Payable		$106,379.00
	(To record right of use asset)

solution c:

Journal Entries
Date	Particulars	Debit	Credit
31-Dec-19	Interest expense Dr	$5,319.00
	Lease payable Dr	$24,681.00
	To Cash		$30,000.00
	(To record lease payment)