Question

At the beginning of 2020, MPK lease restaurant space from Wilson Corporation under a 10-year lease agreement. The contract calls for annual lease payments of $25,000 each at the end of each year. The building was acquired by the Wilson, the lessor, at a cost of $300,000 and is expected to have a useful life of 25 years with no residual value for calculating straight-line depreciation. Wilson seeks a 10% return on its lease investments.

Required:

1. Classify the lease for the lessee, MPK.
2. What will be the effect of the lease on MPK's earnings for the first year, and on the balance sheet at the end of the year (ignore taxes)?
3. Prepare the journal entries for MPK in 2020 and 2021. Round your answers to the nearest whole dollar amounts.
4. Prepare the journal entries for Wilson Corporation in 2020 and 2021. Round your answers to the nearest whole dollar amounts.

Answer 1

1. It will be treated as Operating Lease for the lessee since the Net Present Value(NVP) of lease payment is less than 90% of the assets fair value and also the period for the lease agreement is less than 75% of the asset life so the lease will be treated asOperating Lease for the lessee and it will be treated as rent expense in the books of lessee accounts.

2. MPK's earning for the first year will be deducted by $25,000 as this amount of lease payment will be treated as rent expense and it will appear on the debit side of the balance sheet under the rent expnese head. If MPK make the earning of $75,000 at the end of the year than the total earning og MPK after making the lease payment will be $50,000 because this $25,000 will be treated as rent expense and shall be deducted from the total earning of MPK.

3. Journal Entry of MPK at the end of 2020

Rent expense A/C Dr. $25,000

To Bank A/C $25,000

Journal Entry of MPK at the end of 2021

Rent expnese A/C Dr. $25,000

To Bank A/C $25,000

4. Journal Entry of Wilson at the end of 2020

Bank A/C Dr. $25,000

To Rent Received A/C $25,000

Depreciation on Building A/C Dr. $12,000

To Building A/C $12,000

Journal Entry of Wilson at the end of 2021

Bank A/C Dr. $25,000

To Rent Received A/C $25,000

Depriciation on Building A/C Dr. $12,000

To Building A/C $12,000

Bank A/C Dr. $2,500

To Interest Received A/C $2,500