Question

American Food Services, Inc. leased a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2021. The lease agreement for the $4.5 million (fair value and present value of the lease payments) machine specified four equal payments at the end of each year. The useful life of the machine was expected to be four years with no residual value. Barton and Barton's implicit interest rate was 8%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Prepare the journal entry for American Food Services at the beginning of the lease on January 1, 2021. 2. Prepare an amortization schedule for the four-year term of the lease. 3. & 4. Prepare the appropriate entries related to the lease on December 31, 2021 and 2023.

Answer 1

Solution 1:

Fair value of leased asset = $4,500,000

Implicit interest rate = 8%

Annual lease payments = $4,500,000 / Cumulative PV Factor at 8% for 4 periods

= $4,500,000 / 3.312127

= $1,358,644

Journal Entries - American Food Service
Date	Particulars	Debit	Credit
1-Jan-18	Equipment Dr	$4,500,000.00
	To Lease Liability		$4,500,000.00
	(To record machinery acquired on inception of lease)

Solution 2:

Lease Amortization Schedule
Payment Date	Lease Payments	Effective Interest (8%)	Decrease in Balance	Lease Balance
				$4,500,000
31-Dec-21	$1,358,644	$360,000	$998,644	$3,501,356
31-Dec-22	$1,358,644	$280,108	$1,078,536	$2,422,820
31-Dec-23	$1,358,644	$193,826	$1,164,818	$1,258,002
31-Dec-24	$1,358,644	$100,642	$1,258,002	$0

Solution 3 & 4:

Journal Entries - American Food Service
Date	Particulars	Debit	Credit
31-Dec-21	Interest Expense Dr	$360,000.00
	Lease Liability Dr	$998,644.00
	To Cash		$1,358,644.00
	(To record payment of lease)
31-Dec-21	Depreciation expense Dr ($4,500,000/4)	$1,125,000.00
	To Accumulated Depreciation - Equipment		$1,125,000.00
	(To record depreciation on equipment)
31-Dec-23	Interest Expense Dr	$193,826.00
	Lease Liability Dr	$1,164,818.00
	To Cash		$1,358,644.00
	(To record payment of lease)
31-Dec-23	Depreciation expense Dr ($4,500,000/4)	$1,125,000.00
	To Accumulated Depreciation - Equipment		$1,125,000.00
	(To record depreciation on equipment)