Question

Federated Fabrications leased a tooling machine on January 1, 2021, for a three-year period ending December 31, 2023. The lease agreement specified annual payments of $41,000 beginning with the first payment at the beginning of the lease, and each December 31 through 2022. The company had the option to purchase the machine on December 30, 2023, for $50,000 when its fair value was expected to be $65,000, a sufficient difference that exercise seems reasonably certain. The machine's estimated useful life was six years with no salvage value. Federated was aware that the lessor’s implicit rate of return was 11%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Calculate the amount Federated should record as a right-of-use asset and lease liability for this finance lease.
2. Prepare an amortization schedule that describes the pattern of interest expense for Federated over the lease term.
3. Prepare the appropriate entries for Federated from the beginning of the lease through the end of the lease term.

Answer 1

Federated Fabrications Requirement 1 Requirement 3 Table 6, 3 payments @ 11% = 2.71252 x $41,000 = Table 2, 3 periods @ 11% = .73119 x $50,000 = Total 111213 36560 147773 Journal Enteries Date Particulars 1.1.2021 Right-of-use asset a/c To Lease payable Dr. Debit in $ Credit in 147773 147773 Dr. 41000 1.1.2021 Lease payable a/c To Cash Requirement 2 41000 Principal 31.12.2021 Lease payable a/c Interest expense a/c To Cash Dr. Dr. 29255 11745 41000 Date Payment Interest @ 11% 1.1.2021 1.1.2021 41000 31.12.2021 41000 11745 31.12.2022 41000 8527 30.12.2023 50000 4955 41000 29255 32473 Balance 147773 106773 77518 45045 0 45045 31.12.2021 Amortization expense a/c Dr. 24629 To Right-of-use asset 24629 147773/ 6 = 24629 The asset is depreciated over its estimated useful life rather than the lease term because of the purchase option. 31.12.2022 Lease payable a/c Interest expense a/c To Cash Dr. Dr. 32473 8527 41000 Dr. 24629 31.12.2022 Amortization expense a/c To Right-of-use asset 147773/ 6 = 24629 24629 30.12.2023 Lease payable a/c Interest expense a/c To Cash Dr. Dr. 45045 4955 50000 Dr. 31.12.2023 Amortization expense a/c To Right-of-use asset 147773 / 6 = 24629 24629