Question

Marigold Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2020. Annual rental payments of $43,000 are to be made at the beginning of each lease year (December 31). The interest rate used by the lessor in setting the payment schedule is 7%; Marigold’s incremental borrowing rate is 9%. Marigold is unaware of the rate being used by the lessor. At the end of the lease, Marigold has the option to buy the equipment for $5,000, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Marigold uses the straight-line method of depreciation on similar owned equipment.

1. Prepare the journal entries, that Marigold should record on December 31, 2020.

2. Prepare the journal entries, that Marigold should record on December 31, 2021.

3. Prepare the journal entries, that Marigold should record on December 31, 2022.

4. What amounts would appear on Marigold’s December 31, 2022, balance sheet relative to the lease arrangement?

Answer 1

Calculation of Present Value of Lease Payements:- Date Amount 1 31-Dec-20 31-Dec-21 31-Dec-22 31-Dec-23 31-Dec-24 Present value factor Present Value @9% 43000 430001 0.917 43000 0.842 43000 0.772 43000 0.708 215,000 43000 39431 36206 33196 30444 182,277 Total Lease Liability Amortization Schedule:- Date Interest Expense Annual lease payment 31-Dec-20 31-Dec-20 31-Dec-21 Reduction of lease liabilty Lease liabilty 182,277 0 43000 139,277 12535 30465 108,812 31-Dec-22 9793 33207 75,605 43000 43000) (139277*9%) 43000 (108812*9%) 43000 (75605*9%) 43000 31-Dec-23 6804) 36196 39,409 31-Dec-24 3591 39409

1) Debit Date 31-12-2020 Particulars Leased Equipment Lease liabilty Credit 182,277 182,277 31-12-2020 43000 Lease liabilty Cash 43000 2) Debit Date 31-12-2021 Particulars Depreciation expense (182.277/7) Accumulated depreciation Credit 26,040 26,040 31-12-2021 Interest expense Lease liabilty Cash 12535 30465 43000 3) Debit Date 31-12-2022 Particulars Depreciation expense Accumulated depreciation Credit 26,040 26,040 31-12-2022 Interest expense Lease liabilty Cash 9793 33207 43000