Question

On January 1, 2018, Winn Heat Transfer leased office space under a three-year operating lease agreement. The arrangement specified three annual rent payments of $80,000 each, beginning December 31, 2018, and at each December 31 through 2020. The lessor, HVAC Leasing calculates lease payments based on an annual interest rate of 5%. Winn also paid a $100,000 advance payment at the beginning of the lease in addition to the first $80,000 rent payment. With permission of the owner, Winn made structural modifications to the building before occupying the space at a cost of $180,000. The useful life of the building and the structural modifications were estimated to be 30 years with no residual value.

Required:

Prepare the appropriate entries for Winn Heat Transfer from the beginning of the lease through the end of 2020. Winn’s fiscal year is the calendar year.

Answer 1

Lease

An agreement of contract that is prepared to transfer the right to use the resources for a particular purpose for stipulated time is called lease contract. The person owning the resource is called lessor and the person, to whom right is transferred, is lessee.

Record the entries for WH from beginning of the lease through the end of 2020.

(1) Beginning of the Lease (January 1, 2018)

The entry is to record the lease payment. To record the entry debit right-of-use asset and credit lease payable as shown below:

Working note 1:

Calculate value right-of-use of asset.

Present value of an ordinary annuity of $1: n=3, i=5%.

Therefore, right of use asset is $317,860.

Record the entry for advance lease payment as shown below:

To record the entry debit prepaid rent and credit cash.

First Lease Payment (December 31, 2018)

The entry is to record the lease payment. To record the entry debit interest expense and debit lease payable and credit cash as shown below:

Record entry to transfer advance lease payment with annual lease rentals.

The entry to record transfer of advance payments with annual lease rental to lease payable. To record the entry debit lease payable and credit prepaid rent as shown below:

The entry is to record the amortization expense. To record the entry debit amortization expense and credit right-of-use asset as shown below:

Note:

Straight-line lease expense =

For most leases, the asset and liability will be the same at any point during the life of the lease. If there are uneven payments (advance payment, scheduled rent increases, or scheduled rent decreases), the rent leveling effect will be reflected in the right-of-use asset.

The entry is to record the depreciation expense. To record the entry debit depreciation expense and credit accumulated depreciation – leasehold improvement as shown below:

Second Lease Payment (December 31, 2019).

The entry is to record the lease payment. To record the entry debit interest expense and debit lease payable and credit cash as shown below:

The entry to record transfer of advance payments with annual lease rental to lease payable.

To record the entry debit lease payable and credit prepaid rent as shown below:

The entry is to record the amortization expense. To record the entry debit amortization expense and credit right-of-use asset as shown below:

The entry is to record the depreciation expense. To record the entry debit depreciation expense and credit accumulated depreciation – leasehold improvement as shown below:

Third lease payment (December 31, 2020).

The entry is to record the lease payment. To record the entry debit interest expense and debit lease payable and credit cash as shown below:

The entry to record transfer of advance payments with annual lease rental to lease payable.

To record the entry debit lease payable and credit prepaid rent as shown below:

The entry is to record the amortization expense. To record the entry debit amortization expense and credit right-of-use asset as shown below:

The entry is to record the depreciation expense. To record the entry debit depreciation expense and credit accumulated depreciation – leasehold improvement as shown below: