Question

5. Accounting for Lease Agreement - Lessee (18 points) Gopher Sales and Service entered into a lease agreement to lease a fleet of five vehicles from Hawkeye Motors. The term of the lease is five years and Gopher makes annual payments of $21,000 per year beginning on January 1, 2017 (and then every December 31 through December 31, 2020). January 1, 2017 is also the lease commencement date. Gopher does not guarantee any residual value in the lease agreement. Gopher received $8,000 on 1/1/17 as an incentive to sign the lease agreement and incurred initial direct costs in 2016 of $2,500 related to the lease that were recorded as prepaid assets. The estimated economic life of the vehicles is ten years and their fair value at lease inception is $170,000. Gopher is unaware of Hawkeye's implicit rate, but Gopher's incremental borrowing rate is 4% per year. There is no transfer of ownership at the end of the lease, nor is there a purchase option. The vehicles are not of a specialized nature. Required: a. What type of lease has Gopher signed? Explain in terms of the new US GAAP standard (ASC 842). (2 pts) b. Prepare all of the 2017 journal entries for Gopher. (10 pts) c. Prepare all of the 2018 journal entry(ies) for Gopher. (2 pts) d. Prepare all of the 2021 journal entries for Gopher. (4 points)

Answer 1

1. The Lease is an operating Lease because : the lesee does not have an option to purchase the aseet at the end of its useful life The asset is not of specialized nature The period of lease does not cover the life of the asset substantially.

21000 3.63 Workings Annual Lease Rentals Annuity Factor @ 4% for 4 Years Present Value of Lease Rentals Lease Rental Paid at inceptiom Lease to be recognized 76230 21000 97230 (in $) Year 1 5 2017 2017 2018 Statement Showing Amortization of Lease Rentals Opening Interest @ Total Lease Rentals Balance 4% Paid 2 3= 2*4% 4= 2+3 97,230 97,230 21,000 76,230 3,049 79,279 21,000 58,279 2,331 60,610 21,000 39,610 1,584 41,195 21,000 20,195 805 21,000 21,000 Closing Balance 6 =4-5 76,230 58,279 39,610 20,195 2019 2020

Journal Entries for 2017 1/1/2017 Deferred Lease Rentals A/c Dr 97230 To Lease Rent Payable A/c To Bank A/C (Being Operating Lease recorded at the inception of lease) 76230 21000 8000 1/1/2017 Bank A/c Dr To Incentive A/C (Being Incentive income recognized) 8000 3049 31/12/2017 Interest on Lease Rent Ac Du To Lease Rent Payable A/C (Being interest on Operating Lease recorded) 3049 21000 31/12/2017 Lease Rent Payable A/c Dr To Bank A/C (Being Annual Lease Rent paid for the year) 21000 31/12/2017 Profit & Loss A/c Dr 34500 Incentive A/c Dr 8000 To Prepaid Assets A/c To Deferred Lease Rentals A/C Interest on Lease Rent Ac Dr (Being all items of income and expenses transferred to P&L) 500 38951 3049

2331 31/12/2018 Interest on Lease Rent Ac Dc To Lease Rent Pavable A/c (Being interest on Operating Lease recorded) 3049 21000 31/12/2018 Lease Rent Pavable A/c Dr To Bank A/C (Being Annual Lease Rent paid for the year) 21000 31/12/2018 Profit & Loss A/c Dr 21500 To Prepaid Assets A/C To Deferred Lease Rentals A/C Interest on Lease Rent Ac Dr (Being all items of income and expenses transferred to P&L) 500 18669 2331

31/12/2021 Profit & Loss A/c Dr 500 To Prepaid Assets A/C (Being all items of income and expenses transferred to P&L) 500

Since it was an operating lease, no asset is recorded in the books

Incentive income is recognized immediately

initial direct costs were deferred over a period of 5 years starting from 2017 going through 2021