Question

payable annually every December 31 for 20 years. Title to the equipment passes to Drake at the end of the lease term. The lease is noncancelable.

Additional Facts:

1. The equipment has a $750,000 carrying amount on Brewer’s books. Its estimated economic life was 25 years on January 1, Year 1.
2. The rate implicit in the lease, which is known to Drake, is 10%.
3. Drake’s incremental borrowing rate is 12%.
4. Drake normally uses the straight-line method of depreciation for equipment.
5. The economic life of the equipment did not change as a result of the lease.

The rounded present value factors of an ordinary annuity for 20 years are as follows:

          12%     7.5
          10%     8.5

To prepare each required journal entry:

• Enter the corresponding debit or credit amount in the associated column.
• Round all amounts to the nearest whole number.
• Not all rows in the table might be needed to complete each journal entry.
• If no journal entry is needed, check the “No entry required” box at the top of the table as your response.

1. Record the journal entries for the following accounts for Drake on January 1, Year 1, if any.

No Entry Required

Account Name	Debit	Credit
Right-of-use asset
Lease liability		2. Record the journal entries for the following accounts for Drake on December 31, Year 1, if any. No Entry Required Account Name Debit Credit      Lease liability      Interest expense      Cash 3. Record the journal entries for the following accounts for Drake on December 31, Year 1, if any. No Entry Required Account Name Debit Credit      Amortization expense      Right-of-use asset 4. Record the amounts for the following accounts in Drake's December 31, Year 2, balance sheet. No Entry Required Account Name December 31, Year 2, Balance ($)      Right-of-use asset      Current liabilities: Lease liability      Noncurrent liabilities: Lease liability

Answer 1

Requirement 1:

Date	Account title and explanation	Debit	Credit
Jan 1, Year 1	Right of use asset	$750,000
	Lease liability		$750,000
	[To record the lease]

Requirement 2:

Date	Account title and explanation	Debit	Credit
Dec 31, Year 1	Lease liability	$13,235
	Interest expense (1,764,706 x 10%)	$75,000
	Cash		$88,235
	[To record interest expense]

Calculations:

Carrying value of the equipment	$750,000
÷ Rounded present value factors of an ordinary annuity for 20 years at 10%	8.5
= Annual lease payment	$88,235

Requirement 3:

Date	Account title and explanation	Debit	Credit
Dec 31, Year 1	Amortization expense	$37,500
	Right of use asset		$37,500
	[To record amortization of the right of use asset]

Calculations:

Amortization expense = $750,000 ÷ 20 years = $ 37,500

Requirement 4:

Account name	Dec 31, Year 2, Balance $
Right-of-use asset	$675,000
Current liabilities:
Lease liability	$88,235
Non-current liabilities:
Lease liability	$519,265

Calculations:

i. Right of use asset balance:

= Beginning right-of-use asset - Amortization expense for Year 1 - Amortization expense for Year 2

= $750,000 - $37,500 - $37,500

=$675,000

Current and Non-current lease liability:

Lease amortization table (partial)
Year	Lease payment	Interest expense	Carrying amount
0			$750,000
1	$88,235	$75,000	$675,000
2	$88,235	$67,500	$607,500

Interest expense = Preceding carrying amount x 10% & Carrying amount = Preceding carrying amount - Interest expense

Carrying amount of Year 2 includes current liability of lease payment for the amount of $88,235 and Non-current liability for the amount of $519,265 ($607,500 - $88,235)