Question

On January 1, 2017, Seven Wonders Inc. signed a five-year noncancelable lease with Moss Company. The lease calls for five payments of $277,409.44 to be made at the end of each year. The leased asset has a fair value of $1,200,000 on January 1, 2017. Seven Wonders cannot renew the lease, there is no bargain purchase option, and ownership of the leased asset reverts to Moss at the lease end. The leased asset has an expected useful life of six years, and Seven Wonders uses straight-line depreciation for financial reporting purposes. Its incremental borrowing rate is 12%. Moss’s implicit rate of return on the lease is unknown. Seven Wonders uses a calendar year for financial reporting purposes. Both companies use ASC 840 to account for leases. Use tables (PV of 1, PVAD of 1, and PVOA of 1) (Use the appropriate factor(s) from the tables provided.)

Required:

2. Prepare an amortization schedule for the lease liability.
3. Prepare the journal entry to record.

1. The lease as a capital lease on January 1, 2017.

2. The lease payments on December 31, 2017 and 2018.

3. The leased asset’s depreciation in 2017 and 2018.

4. What is the total amount of expense reported on Seven Wonders’ 2017 income statement from the lease?

Answer 1

a)
Present value of future lease payments: $277,409.44 x the present value of an ordinary annuity at 12% for 5 periods.
Present value of future lease payments: $277,409.44 x 3.60478	$                                                                            10,00,000.00
Seven Wonders Incorporated
Amortization of Capital Lease Liability
	1	2	3= 2-1	Previous year lease liability - liability reduction
Date	Interest Portion 12% x previous year lease liability	Cash Payment (given)	Liability Reduction	Lease Liability
Jan 1,2017				$ 10,00,000.00
Dec 31, 2017	$                                                                              1,20,000.00	$   2,77,409.44	$   1,57,409.44	$   8,42,590.56
Dec 31, 2018	$                                                                              1,01,110.87	$   2,77,409.44	$   1,76,298.57	$   6,66,291.99
Dec 31, 2019	$                                                                                 79,955.04	$   2,77,409.44	$   1,97,454.40	$   4,68,837.59
Dec 31, 2020	$                                                                                 56,260.51	$   2,77,409.44	$   2,21,148.93	$   2,47,688.66
Dec 31, 2021	$                                                                                 29,722.64	$   2,77,409.44	$   2,47,688.66	$             -0.00
b)
Journal entries
Date	Account Titles & Explanation	Debit	Credit
The lease as a capital lease on January 1, 2017.
January 1, 2017.	Leased assets—capital leases	$ 10,00,000.00
	Obligations under capital leases		$ 10,00,000.00
The lease payments on December 31, 2017 and 2018
Dec 31, 2018	Interest expense	$   1,20,000.00
	Obligations under capital leases	$   1,57,409.44
	Cash		$   2,77,409.44
Dec 31, 2019	Interest expense	$   1,01,110.87
	Obligations under capital leases	$   1,76,298.57
	Cash		$   2,77,409.44
The leased asset’s depreciation in 2017 and 2018
Dec 31, 2018	Depreciation Expenses (1000000/5)	$   2,00,000.00
	Accumulated depreciation—leased assets		$   2,00,000.00
Dec 31, 2019	Depreciation Expenses (1000000/5)	$      93,767.52
	Accumulated depreciation—leased assets		$      93,767.52
c)
Under the capital lease method, the total expense recognized in 2017 (interest expense + depreciation) = ($120,000 + $200,000 = $320,000)