Question

2- Pass a journal entries in the books of lease contract by creating lease receivable at its net investment in which is equal to the minimum lease payments discounted at the rate of interest implicit in the lease.

3- Pass a journal entries in the in recognition of both an asset and a liability in the books of the lessee at the inception of the lease at amount equal to present value of minimum lease payments.

4- Journalize the transactions in the books of lessor and lessee if the lease meets the criteria for recognition as an operating lease instead of a finance lease.

solve by example

Answer 1

The below is the example for the finaNcial and operating lease of AABC company

AABC Inc. is a rail company which has leased out diesel generators from JK, Ltd. to provide backup to the transportation system during power outages. The lease has 5-year term in which ABC has to make $500,000 payment to JK at the end of each year. Journalize the inception of the lease and the first payment made by ABC in the books of the ABC and JK if PV of minimum lease payments is $1,996,355 and rate of interest implicit in the lease is 8%.

Accounting for Lessor

The lessor shall record the start of a lease by creating a lease receivable at its net investment in lease, which is equal to the minimum lease payments discounted at the rate of interest implicit in the lease.

Journal entry posted at the start of the lease contract:

Lease receivable	$1,996,355
Asset		$1,996,355

At the time of first payment, lessor shall record receipt of cash, reduction in lease receivable and recognition of finance income:

Cash	$500,000
Lease receivable ($500,000-40,000)		$460,000
Finance income ($500,000×8%)		$40,000

The reduction in lease receivable reduces the principal balance in lease receivable to $1,536,355, which shall reduce the next year finance income.

Accounting for Lessee

A finance lease results in recognition of both an asset and a liability in the books of the lessee at the inception of the lease at amount equal to present value of minimum lease payments.

Leased asset	$1,996,355
Lease liability		$1,996,355

It is quite possible that the lease asset and lease liability are recorded at the different amounts in the books of lessor and lessee.

At the time of first annual payment, the lessee records the following journal entry:

Lease liability a/c Dr	$460,000
Interest expense ($500,000 × 8%) a/c Dr	$40,000
To Cash a/c		$500,000

At the end of first year, the lessee shall post one additional entry to recognize the depreciation expense on the leased asset. It depreciates the leased asset as if it is an owned asset.

Operating Lease: Example

Accounting for operating leases is pretty straightforward because they do not involve recognition of any asset or liability. The lease income is recognized on a basis reflecting the use of the asset.

Refer to the example above for finance lease. Journalize the transactions in the books of lessor and lessee if the lease meets the criteria for recognition as an operating lease instead of a finance lease.

Accounting for Lessor

No journal entry shall be made the start of the lease contract.

During the first year, the lessor shall recognize receipt of lease rental as follows:

Cash a/c Dr	$500,000
To Lease rental income a/c		$500,000

Accounting for Lessee

No journal entry shall be made at the start of the lease.

At the time of first payment, the following journal entry is required:

Lease expense a/c Dr	$500,000
To Cash a/c		$500,000