Question

Fox Financing, Inc. leased a drilling machine to lease to Guy Company. The noncancelable lease requires lease payments of $5,000 per year, payable in advance, over a four year period. There is a bargain purchase option of $10,000 for Guy. Fox's implicit interest rate (known to Guy) is 10 percent. The lease term begins on January 1, 2019. The machine's economic life is 10 years. The machine's book value is $22,000 and fair value $25,000. The collectability of the lease payments is probable for the lessor. (Present value of an ordinary annuity of 1 for 4 periods at 10% Is 3.16986, of an annuity due of 1 for 4 periods at 10% is 3.48685. Present value of 1 for 4 periods at 10% is 0.66301). Notes: Read carefully and follow strictly so that Bb can grade you correctly! 1. Use comma in numbers, one thousand is 1,000, not 1000. No $ sign. No positive or negative sign. 2. If no entry is required, write N/A. 3. Only use the following accounts: Cash, CGS, Lease receivable, Inventory, Sales revenue, Interest revenue, RoU asset, Lease liability, Depreciation expense, Interest expense. 4. Copy account names accurately to receive credits, names are not case sensitive 1. Provide the journal entries required on the lessee's books through January 1, 2019. 1/1/2019 journal entries for acquiring the lease asset: Account Dr. Account Cr

Answer 1

Solution: According to the terms of lease, there is a bargain purchase option and a non-cancellable lease. Therefore, the given lease shall be treated as a Capital/Financial Lease.

In the books of Lessee
	Account Name	Dr. Amount	Account Name	Cr. Amount
	Journal Entry for Acquiring the lease of Asset
1.1.2019	Equipment Account	17,434	Lease Liability	17,434
	Journal Entry for the first Payment
1.1.2019	Lease Liability Account	5,000	Cash Account	5,000
	Journal Entry for Depreciation
31.12.2019	Depreciation Expense Account	4,359	Accumulate Depreciation Account	4359
	Journal Entry for Interest
31.12.2019	Interest Expense Account	1,243	Interest Payable Account	1,243
	Journal Entry for Lease Payment
1.1.2020	Lease Liability Account	3,757	Cash Account	5,000
	Interest Payable Account	1,243

In the books of Lessor
Date	Account Name	Dr. Amount	Account Name	Cr. Amount
	Journal Entry for Leasing the Asset
1.1.2019	Lease Receivable Account	17,434	Equipment Account	17,434
	Journal Entry for receiving first Payment
1.1.2019	Cash Account	5,000	Lease Receivable Account	5,000
	Journal Entry for Interest
31.12.2019	Interest Receivable Account	1,243	Interest Income Account	1,243
	Journal Entry for receiving Lease Payment
1.1.2020	Cash Account	5,000	Lease Receivable Account	3,757
			Interest Receivable Account	1,243

*Working Notes

1. Since the lease payments are made in advance therefore it is Annuity due. Therefore,  the applicable present value of annuity due = 3.48685.

Thus, Present Value of Annuity due = 5,000*3.48685=17,434.25 or 17,434 (rounded off to nearest whole number)

Lease Amortisation Schedule

Year	Opening Balance	Interest Expense	Payment	Principal Payment	Closing Balance
1	12,434	1,243	50,00	3,757	8,677
2	8,677	868	5,000	4,132	4,545
3	4,545	455	5,000	4,545	0

2019 is taken as current year (Year 0)

- For Year 1 (2020), Opening Balance = 17,434-5,000 (Present Value of Annuity due-Lease Payment in Year 0

- Interest Expense is calculated as Opening Balance*0.10 (i.e. 10%)

- Annual Payment is given as 5,000

- Principal Payment= Opening Balance- Interest Expense

- Closing Balance = Opening Balance- Principal Payment