Question

PROBLEM:

On January 1, 2019 Day Co. leased a new machine from Parr with the following pertinent information:

Lease term                                                                                      6 years

Annual rental payable at the beginning of each year        $50,000

Useful life of machine                                                                  8 years

Day’s incremental borrowing rate                                          15%

Implicit interest rate in lease (known by Day)                     12%

Present value of annuity of 1 in advance for 6 periods at

            12%                                                                                        4.61

            15%                                                                                        4.35

The lease passes ownership of the machine to Day at the termination of the lease. The cost of the machine on Parr’s accounting record is $375,500.

Hint: see bottom of pages 839 - 841 (chapter 15) of your text book for an illustrative example. Please write your answers in the space provided in each question.

QUESTIONS:

1. At the beginning of the lease term, Day should record a lease liability of

1. $375,500
2. $230,500
3. $217,500
4. $0

2. Is this a capital or operating lease?

3. Record/Journalize the entry Day should make at the inception/beginning of the lease Jan 1, 2019

4. Record/journalize Day’s annual lease payment at end of 2019

5. Record/journalize Day’s annual interest payment at end of 2019 (use the effective interest rate method)

6. How much is Day’s lease liability at the end of 2019.

Answer 1

Answer :

Lease liability at the beginning of the lease term = Annual rental payable at the beginning of the each year * present value of annuity of 1 in advance for periods at 12%

Lease liability at the beginning of the lease term = $40,000 * 4.61

Lease liability at the beginning of the lease term = $230,500

Hence, the correct answer is (b). $230,500

This is a capital lease because the lessor passes ownership of the machine to day at the termination of the lease

The entry Day should make at the inception / beginning of the lease Jan 1,2019

Date	Accounts Title and Explanation	Debit	Credit
1.Jan.2019	Right of use Asset	$230,500
	Lease Liability		$230,500
	(To record lease liability)

Day's annual lease payment at the end of 2019

Reduction in lease liability = $50,000-($230,500*12%) = $22,340

Date	Accounts Title and Explanation	Debit	Credit
31. Dec .2019	Right of use Asset	$22,340
	Cash		$22,340
	(To record lease payment)

Day's annual interest payment at end of 2019

Interest expense = $230,500 *12% = $27,660

Date	Accounts Title and Explanation	Debit	Credit
31. Dec .2019	Interest Expense	$27,660
	Cash		$27,660
	(To record interest expense)

Day's lease liability at the end of 2019 = $230,500 - $22,340 = $208,160