Question

Laura Leasing Company signs an agreement on January 1, 2017, to lease equipment to Kingbird Company. The following information relates to this agreement.

1.		The term of the non-cancelable lease is 3 years with no renewal option. The equipment has an estimated economic life of 5 years.
2.		The fair value of the asset at January 1, 2017, is $62,000.
3.		The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $4,000, none of which is guaranteed.
4.		The agreement requires equal annual rental payments of $20,250 to the lessor, beginning on January 1, 2017.
5.		The lessee’s incremental borrowing rate is 5%. The lessor’s implicit rate is 4% and is unknown to the lessee.
6.		Kingbird uses the straight-line depreciation method for all equipment.

Assume that the expected residual value at the end of the lease is $10,000, such that the payments are $18,402.

Click here to view the factor table.

Prepare all of the journal entries for the lessee for 2017 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31. (For calculation purposes, use 5 decimal places as displayed in the factor table provided and round answers to 0 decimal places, e.g. 5,265. Credit account titles are automatically indented when the amount is entered. Do not indent manually.)

Date	Account Titles and Explanation	Debit	Credit
1/1/17	enter an account title To record the lease on January 1 2017	enter a debit amount	enter a credit amount
	enter an account title To record the lease on January 1 2017	enter a debit amount	enter a credit amount
	(To record the lease)
	enter an account title To record lease liability on January 1 2017	enter a debit amount	enter a credit amount
	enter an account title To record lease liability on January 1 2017	enter a debit amount	enter a credit amount
	(To record lease liability)
12/31/17	enter an account title for the journal entry on December 31 2017	enter a debit amount	enter a credit amount
	enter an account title for the journal entry on December 31 2017	enter a debit amount	enter a credit amount
	enter an account title for the journal entry on December 31 2017	enter a debit amount	enter a credit amount

Answer 1

Solution

Kingbird Company

Entries in the books of lessee:

Journal Entries

Journal Entries
Date	Account Titles and Explanation	Debit	Credit
1//1/17	Leased Equipment	$57,903
	Lease Liability		$57,903
	(To record the inception of lease)
01-01-2017	Lease Liability	$20,250
	Cash		$20,250
	(To record first payment made)
Dec 31, 2017	Lease Liability	$18,367
	Interest Expense	$1,883
	Cash		$20,250
	(To record annual payment and interest expense)
Dec 31, 2017	Depreciation Expense - Leased Equipment	$19,301
	Accumulated Depreciation - Leased Equipment		$19,301
	(To record depreciation; 57,903/3 = $17,283)

Note: The leased asset is depreciated over the shorter of the lease term or useful life of asset. Lease term = 3 years and useful life of asset = 5 years. Hence, asset is depreciated over three years.

Computations:

1. Lease liability to Kingbird

Since lease payments are made in advance, annuity due table factors are used to compute the lease liability.

Since the implicit rate of lessor is unknown to lessee, the lease liability is computed using the incremental borrowing rate of 5%.

Also, salvage value is not considered for computation of liability as the same is unguaranteed.

Lease liability = annual rental payment x annuity due at 5% for 3 years

Annual rental payment = $20,250

Annuity due factor at 5% for 3-year period = 2.8594

Lease liability = 20,250 x 2.8594 = $57,903

Amortization schedule –

period	Beginning balance	Interest	annual rental	principal payment	Liability ending balance
0	$57,903	-	$20,250	$20,250	$37,653
1	$37,653	$1,883	$20,250	$18,367	$19,286
2	$19,286	$964	$20,250	$19,286	0
3	0	0		0	0