Question

Problem 3. Watt Financing leased a packing machine to Nuts Company. The noncancelable lease requires lease payments of $50,000 per year, payable in advance, over a five-year period. There is a bargain purchase option of $20,000 for Nuts. Watt's implicit interest rate (known to Nuts) is 11 percent. The lease term begins on January 1, 2019. The machine's economic life is 10 years with a cost of $200,000. The collectability of the lease payments is probable for the lessor. Instructions Provide the journal entries required on both Watt 's and Nuts' books to record the lease transaction through December 31, 2020.

Answer 1

This lease as finance lease because the lease has bargaining purchased option.
Year	PV factor @11%
0	1.00000
1	0.90090
2	0.81162
3	0.73119
4	0.65873
5	0.59345
Total PV annuity due (Total of 0 to 4)	4.10245
Present value of lease payments (50000*4.10245)	$        205,123
Present value of bargaining purchase option (20000*0.59345)	$          11,869
Total present value	$        216,992

Lease amortization table
Date	Beginning balance of lease payable	Lease payment	Interest expense (beginning balance of lease payable *11% )	Reduction in lease payable (lease payment - interest expense)	Beginning balance of lease payable (beginning balance of lease payable - reduction in lease payable)
Jan 1, 2019	216,992	50,000		50,000	166,992
Jan 1, 2020	166,992	50,000	18,369	31,631	135,361
Jan 1, 2021	135,361	50,000	14,890	35,110	100,250
Jan 1, 2022	100,250	50,000	11,028	38,972	61,278
Jan 1, 2023	61,278	50,000	6,741	43,259	18,018
Jan 1, 2024	18,018	20,000	1,982	18,018	0

Lessee (Nuts)
Journal entries
Date	General Journal	Debit	Credit
Jan 1, 2019	Right of use asset	$        216,992
	Lease liability		$        216,992
	(To record the lease)
Jan 1, 2019	Lease liability	$          50,000
	Cash		$          50,000
	(to record Lease liability paid)
Dec 31, 2019	Interest expense	$          18,369
	Lease liability		$          18,369
	(To record accrued interest expense.)
Dec 31, 2019	Amortization Expense	$          21,699
	Right of use Asset		$          21,699
	(To record Amortization.) (216992/10)
Jan 1, 2020	Lease liability	$          50,000
	Cash		$          50,000
	(to record Lease liability paid)
Dec 31, 2020	Interest expense	$          14,890
	Lease liability		$          14,890
	(To record accrued interest expense.)
Dec 31, 2020	Amortization Expense	$          21,699
	Right of use Asset		$          21,699
	(To record Amortization.) (216992/10)

Lessor (Watt)
Journal entries
Date	General Journal	Debit	Credit
Jan 1, 2019	Lease receivable	$        216,992
	Cost of goods sold	$        200,000
	Sales revenue		$        216,992
	Inventory		$        200,000
	(To record lease agreement for sales type lease.)
Jan 1, 2019	Cash	$          50,000
	Lease Receivable		$          50,000
	(To record Lease payment received.)
Dec 31, 2019	Lease receivable	$          18,369
	Interest Revenue		$          18,369
	(To record accrued Interest Revenue.)
Jan 1, 2020	Cash	$          50,000
	Lease Receivable		$          50,000
	(To record Lease payment received.)
Dec 31, 2020	Lease receivable	$          14,890
	Interest Revenue		$          14,890
	(To record accrued Interest Revenue.)