Question

Problem 4. On January 1, 2019. Erk, the lessee, and Betty, the lessor, signed a noncancelable lease agreement for Betty's equipment with a carrying amount of $75,000. The lease term is seven years with rental payments of $10,000 at the beginning of each year. Erk's incremental borrowing rate is 9%. The equipment is expected to have a residual value of $15,000 at the end of the lease, unguaranteed, and a useful life of 15 years. The collectability of the lease payments is probable for the lessor Betty. Instructions a. Determine the present value of the lease payments. b. Classify the lease from the standpoint of the lessee and lessor, giving reasons. c. Prepare the journal entries of the lessee through December 31, 2020. d. Prepare the journal entries of the lessor through December 31, 2020.

Answer 1

a. Present value of lease Payment by using BA II Plus calculator

N -7 years, PMT-$10,000 , I/Y- 9% , FV -0 , CPT - PV is $50329

b.Lease can be classified as capital lease or operating lease :

Capital lease transfers to the lessee virtually all rewards and risks that accompany ownership of property. A lease is a capital lease if, among other provisions, it (1) transfers ownership of the leased property to the lessee at the end of the lease term or (2) contains a bargain purchase option that permits the lessee to buy the property at a price significantly below fair market value at the end of the lease term.

A capital lease is a means of financing property acquisitions; it has the same economic impact as a purchase made on an installment plan. Thus, the lessee in a capital lease must record the leased property as an asset and the lease obligation as a liability. Because a capital lease is an asset, the lessee depreciates the leased property over its useful life. The lessee records part of each lease payment as interest expense and the balance as a payment on the lease liability

Operating lease : A lease that does not qualify as a capital lease is an operating lease. A one-year lease on an apartment and a week’s rental of an automobile are examples of operating leases. Such leases make no attempt to transfer any of the rewards and risks of ownership to the lessee. As a result, there may be no recordable transaction when a lease is signed.

From the standpoint from Lessor & lessee its operating lease .

C. Journal entry in the books of Lessee

Date	Particulars	Debit	Credit
1st Jan 2019	Prepaid Rent	10,000
	Cash		10,000
	To record rent cash payment

Date	Particulars	Debit	Credit
31st Dec 2019	Rent Expense	10,000
	Prepaid Rent		10,000
	To record rent expense.

Date	Particulars	Debit	Credit
1st Jan 2020	Prepaid Rent	10,000
	Cash		10,000
	To record rent cash payment

Date	Particulars	Debit	Credit
31st Dec 2020	Rent Expense	10,000
	Prepaid Rent		10,000
	To record rent expense.

d. Journal entry in the books of Lessor

Date	Particulars	Debit	Credit
1st Jan 2019	Cash	10,000
	Advance Rent		10,000
	To record cash receipt of rent
Date	Particulars	Debit	Credit
31st Dec 2019	Advance Rent	10,000
	Rent Income		10,000
	To record rent Income
Date	Particulars	Debit	Credit
1st Jan 2020	Cash	10,000
	Advance Rent		10,000
	To record cash receipt of rent
Date	Particulars	Debit	Credit
31st Dec 2020	Advance Rent	10,000
	Rent Income		10,000
	To record rent Income