Question

On January 1, 2018, Rick’s Pawn Shop leased a truck from Corey Motors for a six-year period with an option to extend the lease for three years. Rick’s had no significant economic incentive as of the beginning of the lease to exercise the 3-year extension option. Annual lease payments are $10,000 due on December 31 of each year, calculated by the lessor using a 5% interest rate. The agreement is considered an operating lease.

Required:

1. Prepare Rick’s journal entry to record for the right-of-use asset and lease liability at January 1, 2018.

2. Prepare the journal entries to record interest and amortization at December 31, 2018.

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.

(1) Prepare R’s journal entry to record for the right-for-use and the lease liability at January 1, 2018:

The lease term will be 6 years. The lease term is the contractual lease term modified by any renewal or termination options for which exercise of the options is “reasonably certain.”

The first entry is to record the right-to-use asset on January 1, 2018. To record the entry, debit right-to-use asset and credit lease payable as shown below:

(2) Prepare the journal entries to record the interest and amortization at December 31, 2018:

In an operating lease, the lessee records interest the normal way (at the effective interest rate) and then “plugs” the right-of-use asset amortization at the amount needed for interest plus amortization to equal the straight-line lease payment. The lessee records that amount as a single lease expense in the income statement.

The entry is to record the lease payment on January 1, 2018. To record the entry, debit interest expense, debit lease payable and credit cash account as shown below:

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