Question

The following facts pertain to a non-cancelable lease agreement between Ford and NextCar, a lessee.

                Lease Origination Date                                                                                                                   May 1, 2017

                Annual lease payments due at the beginning of each lease year                                   $20.471.94

                Bargain purchase option price at the end of lease term                                                   $4,000

                Lease term                                                                                                                                          5 years

                Economic life of leased equipment                                                                                          10 years

                Lessor’s cost                                                                                                                                       $65,000

                Fair value of asset on May 1, 2017                                                                                             $91,000

                Fair value of asset on May 1, 2022                                                                                             $15,000

                Lessor implicit rate                                                                                                                          8%

                Lessee’s incremental borrowing rate                                                                                       8%

The collectability of the lease payments is probable.

1. What type of lease is this and why?

2. Prepare a lease amortization schedule for NextCar for the 5-year term.

3. Prepare the journal entries on the lessee’s book to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2017 and 2018. NextCar has an April 30^th year end.

Answer 1

Relevant Information Given -

A noncancelable lease agreement between Ford and NextCar, a lessee.

Lease Origination Date = May 1, 2017

Annual lease payments due at the beginning of each lease year = $20471.94

Bargain purchase option price at the end of lease term = $4000.

Lease term = 5 Years.

Economic life of leased equipment = 10 Years.

Fair value of asset on May 1, 2017 = $91000.

Fair value of asset on May 1, 2022 = $15000 [This is Residual value].

Lessor’s implicit rate = 8%.

Lessee’s incremental borrowing rate = 8%.

.

Answer - Part - (a) -

This is Capital lease, because a bargain-purchase option is involved, that enables the lessee, at the end of the lease, to purchase the asset at a discounted price.

.

Answer - Part - (b) -

Lease Amortization Schedule

Date	Annual Lease Payment Plus BPO ($)	Interest on Liability ($)	Reduction of Lease Liability ($)	Lease Liability ($)
5/1/17	-	-	-	91000 [Given in question]
5/1/17	20471.94 [Given in question]	-	20471.94	70528.06 [91000 - 20471.94]
4/30/18	20471.94 [Given in question]	5642.24 [70528.06 * 8%]	14829.7 [20471.94 - 5642.24]	55698.36 [70528.06 - 14829.7]
4/30/19	20471.94 [Given in question]	4455.87 [55698.36 * 8%]	16016.07 [20471.94 - 4455.87]	39682.29 [55698.36 - 16016.07]
4/30/20	20471.94 [Given in question]	3174.58 [39682.29 * 8%]	17297.36 [20471.94 - 3174.58]	22384.93 [39682.29 - 17297.36​​​​​​​]
4/30/21	20471.94 [Given in question]	1790.79 [22384.93 * 8%]	18681.15​​​​​​​ [20471.94 - 1790.79]	3703.78 [22384.93 - 18681.15​​​​​​​]
4/30/22	4000 [Given in question]	296.30​​​​​​​ [3703.78 * 8%]	3703.7 [4000 - 296.30​​​​​​​]	0 [3703.78 - 3703.7]

.

Answer - Part - (c) -

Journal Entries in the Books of NextCar (lessee)

Date	Account Titles and Explanation	Debit ($)	Credit ($)
5/1/17	Lease equipment Lease Liability (To record the lease) Note - Fair value of asset at May 1, 2017 = $91000, [Given]	91000 -	- 91000
5/1/17	Lease Liability Cash (To record the first lease payment.)	20471.94 -	- 20471.94
4/30/18	Interest Expense [($91000-$20471.94)*8%] Lease Liability [Difference] Cash (To record lease payment along with interest)	5642.24 14829.7 -	- - 20471.94
4/30/18	Depreciation Expense Accumulated Depreciation (To record depreciation) = [($91000 - $15000) / 10 years] = $7600 Note - Because a bargain-purchase option was involved, the leased asset is depreciated over its economic life rather than over the lease term.	7600 -	- 7600
4/30/19	Interest Expense [$55698.36 * 8%] Lease Liability [Difference] Cash (To record lease payment along with interest)	4455.87 16016.07 -	- - 20471.94
4/30/19	Depreciation Expense Accumulated Depreciation (To record depreciation) = [($91000 - $15000) / 10 years] = $7600	7600 -	- 7600