Question

On January 1, 2017, Bramble Company contracts to lease equipment for 5 years, agreeing to make a payment of $879,904 at the beginning of each year, starting January 1, 2017. The leased equipment is to be capitalized at $4,000,000. The asset is to be amortized on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Bramble’s incremental borrowing rate is 6%, and the implicit rate in the lease is 5%, which is known by Bramble. Title to the equipment transfers to Bramble at the end of the lease. The asset has an estimated useful life of 5 years and no residual value.

1.Prepare the journal entries that Bramble should record on January 1, 2017. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answers to 0 decimal places, e.g. 5,275.) 2.Prepare the journal entries to record amortization of the leased asset and interest expense for the year 2017. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round answers to 0 decimal places, e.g. 5,275.) 3.Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answers to 0 decimal places, e.g. 5,275.) 4.What amounts will appear on the lessee’s December 31, 2017, balance sheet relative to the lease contract? What amounts will appear on the lessee's December 31, 2017, balance sheet relative to the lease contract? BRAMBLE COMPANY Balance Sheet (Partial) For the Year Ended December 31, 2017 Assets , Liabilities $

5. How would the value of the lease liability in part (b) change if Bramble also agreed to pay the fixed annual insurance on the equipment of $2,000 at the same time as the rental payments? (Round answers to 0 decimal places, e.g. 5,275.)

Answer 1

1.

Pass the following journal entries on January 1, 2017:

Credit ($) Date Jan-1-2017 Debit ($) $4,000,000 Account Title and Explanation Right use of asset Lease liability (To record the asset taken on lease) $4,000,000 Jan-1-2017 Lease liability 879,904 Cash 879,904 (To record the lease liability paid)

2.

Pass the following journal entries to record amortization of the leased asset and interest expenses for the year 2017:

Credit ($) Debit ($) $156,005 Date Account Title and Explanation Dec-31-2017 Interest expenses Interest payable (To record accrued interest expenses) $156,005 1,600,000 Dec-31-2017 Amortization expenses Right of use asset (To record amortization) 1,600,000

Note:

The asset is amortized on a double-declining-balance-basis (4,000,000/5 x 2)

3.

Pass the following journal entries to record lease payment of January 1, 2018, assuming reversing entries are not made:

Credit ($) Date Jan-1-2018 Account Title and Explanation Interest payable Lease liability Cash (To record lease expense) Debit ($) $156,005 723,899 $879,904

4.

The amount that will appear on December 31, 2017, on lessee's balance sheet relative to the lease contract is $4,000,000 - $879,904 = $3,120,096

5.

Lease liability includes the cost of the asset, hence fixed annual insurance on the leased asset $2,000 would not affect the lease liability and it would be recorded separately from the lease.

Working Note:

Prepare lease amortization and interest expense table for lessee as follows:

b c = a*5% a-d Date Lease payment Interest expenses 1-Jan-17 1-Jan-18 1-Jan-19 1-Jan-20 1-Jan-21 Balance at the beginning of the year 4,000,000 3,120,096 2,396,197 1,636,103 838,004 879,904 879,904 879,904 879,904 879,904 d = b-c Reduction of interest from lease payable 879,904 723,899 760,094 798,099 838,004 Closing balance of lease payable at the end of year 3,120,096 2,396,197 1,636,103 838,004 156,005 119,810 81,805 41,900

Interest expense from first lease payment is not deducted since it is paid on the same day of lease asset acquired.