Question

On January 1, 2019 Day Co. leased a new machine from Parr with the following pertinent information:

Lease term                                                                                       6 years

Annual rental payable at the beginning of each year        $50,000

Useful life of machine                                                                  8 years

Day’s incremental borrowing rate                                           15%

Implicit interest rate in lease (known by Day)                     12%

Present value of annuity of 1 in advance for 6 periods at

            12%                                                                                        4.61

            15%                                                                                        4.35

The lease passes ownership of the machine to Day at the termination of the lease.  The cost of the machine on Parr’s accounting record is $375,500.  

1. At the beginning of the lease term, Day should record a lease liability of

1. $375,500
2. $230,500
3. $217,500
4. $0

2. Is this a capital or operating lease?

3. Record/Journalize the entry Day should make at the inception/beginning of the lease Jan 1, 2019

4. Record/journalize Day’s annual lease payment at end of 2019

5. Record/journalize Day’s annual interest payment at end of 2019 (use the effective interest rate method)

6. How much is Day’s lease liability at the end of 2019.

7. Record/journalize the depreciation @ the end of 2019.

Answer 1

lease liability at the beginning of the lease term = Annual rental payable at the beginning of each year * Present value of annuity of 1 in advance for 6 periods at 12%

lease liability at the beginning of the lease term = $50,000 * 4.61

lease liability at the beginning of the lease term = $230,500

Hence, the correct answer is b. $230,500

This is a capital lease because the lessor passes ownership of the machine to Day at the termination of the lease

the entry Day should make at the inception/beginning of the lease Jan 1, 2019

Date Account Titles and Explanation Debit Credit $230,500 1-Jan-2019 Right of Use Asset Lease Liability (To record lease liability) $230,500

Day’s annual lease payment at end of 2019

reduction in lease liability = $50,000-($230,500*12%) = $22,340

Date Account Titles and Explanation Debit Credit $22,340 31-Dec-2019 Lease Liability Cash (To record lease payment) $22,340

Day’s annual interest payment at end of 2019

interest expense = $230,500 * 12% = $27,660

Date Account Titles and Explanation Debit Credit $27,660 31-Dec-2019 Interest Expense Cash (To record interest expense) $27,660

Day’s lease liability at the end of 2019 = $230,500 - $22,340 = $208,160

the depreciation journal entry at the end of 2019

depreciation expense =$230,500 / 6 = $38,417

Date Account Titles and Explanation Debit Credit $38,417 31-Dec-2019 Depreciation Expense Right of Use Asset (To record depreciation) $38,417