Question

Lessee Company leases heavy equipment on January 1, 2016, under a capital lease from Lessor Company with the following lease provisions:

1. The lease is non-cancelable and has a term of 10 years

2. The lease does not contain a renewal or bargain purchase option

3. The annual rentals are 27,653.77, payable at the beginning of each year.

4. Lessee agrees to pay all executory costs

5. The interest rate implicit in the lease is 12%, which is known by Lessee.

6. The residual value of the property at the end of 10 years is estimated to be zero.

7. The cost and fair value of the equipment to the lessor is 175,000

8. The lessor incurs no material initial direct costs

9. The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor.

10. Lessee's incremental borrowing rate is 15% and it uses the straight-line method to record depreciation on similar equipment.

11. In 2016, the lessee pays insurance of $1,900, property taxes of $1,300 and maintenance of $600.

12. In 2017, the lessee pays insurance of $1,800, property taxes of $1,200 and maintenance of $500.

Identify the type of lease involved for both the lessee and the lessor, and give reasons for your classifications.

Prepare all the journal entries for both the lessee and lessor for 2016 and 2017.

Answer 1

First of all type of Lease given in the question-

Lease is an arrangement between two parties i.e. lessor and lessee, in which lessor gives right to use the asset for a period for a consideration  called Lease.

In the given question lease type is operating Lease due to following reason

1. Ownership of the asset is not transferred at the end of the lease period.

2. Lessee does not have an option to buy the leased asset.

Accounting Entries of Lease Transaction

Year	Particulars	In the Books of Lessor	In the Books of Lessor
2016	lease taken	Equipment A/c Dr 184516 To Cash 26653.77 To Lease Liability 158262
	Interest	Interest Expense A/c Dr 23739 To Interest Payable 23739
	Deprecation	Dep Ac dr 17500 To Accum Dep 17500
	Lease payment	Lease Liability a/c Dr 26653.77 To Cash 26653.77	Lease ac Dr. 26653.77 To Bank 26653.77
2017		Lease Liability a/c Dr 26653.77 To Cash 26653.77	Lease ac Dr. 26653.77 To Bank 26653.77
	Interest	Interest Expense A/c Dr 19741 To Interest Payable 19741
	Deprecation	Dep Ac dr 17500 To Accum Dep 17500