91Ó°ÊÓ

(Amortization Schedule and Journal Entries for Lessee) Laura Leasing Company signs an agreement on January 1, 2017, to lease equipment to Plote Company. The following information relates to this agreement.

1. The term of the noncancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years.
2. The fair value of the asset at January 1, 2017, is \(80,000.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of \)7,000, none of which is guaranteed.
4. Plote Company assumes direct responsibility for all executory costs, which include the following annual amounts: (1) \(900 to Rocky Mountain Insurance Company for insurance and (2) \)1,600 to Laclede County for property taxes.
5. The agreement requires equal annual rental payments of $18,142.95 to the lessor, beginning on January 1, 2017.
6. The lessee’s incremental borrowing rate is 12%. The lessor’s implicit rate is 10% and is known to the lessee.
7. Plote Company uses the straight-line depreciation method for all equipment.
8. Plote uses reversing entries when appropriate.

Instructions

(Round all numbers to the nearest cent.)

(b) Prepare all of the journal entries for the lessee for 2017 and 2018 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31.

Step by step solution

01

Meaning of Lease

A lease is a lawful agreement between the lessor and lessee. In a lease, the lessor is the owner of the asset. The lessee is in obligation to pay the lease amount to the lessor according to the lease agreement.

02

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
Jan. 1, 2017	Leased Equipment	75,653.56
	Lease Liability		75,653.56
Jan. 1, 2017	Lease Liability	18,142.95
	Cash		18,142.95
During 2017	Insurance Expense	900.00
	Cash		900.00
During 2017	Property Tax Expense	1,600.00
	Cash		1,600.00
Dec. 31, 2017	Interest Expense	5,751.06
	Interest Payable		5,751.06
Dec. 31, 2017	Depreciation Expense	15,130.71
	Accumulated Depreciation Capital Leases		15,130.71
Jan. 1, 2018	Interest Payable	5,751.06
	Interest Expense		5,751.06
Jan. 1, 2018	Interest Expense	5,751.06
	Lease Liability	12,391.89
	Cash		18,142.95
During 2018	Insurance Expense	900.00
	Cash		900.00
During 2018	Property Tax Expense	1,600.00
	Cash		1,600.00
Dec. 31,2018	Interest Expense	4,511.87
	Interest Payable		4,511.87
Dec. 31, 2018	Depreciation Expense	15,130.71
	Accumulated Depreciation Capital Leases.		15,130.71

Working Notes:

Calculation of Accumulated depreciation

$$\begin{gathered} \text{Accumulated}\text{depreciation =}\frac{\text{Leased}\text{equipment}}{\text{Useful}\text{life}} \\ =\frac{\$75,653.56}{5} \\ =\$15,130.71 \end{gathered}$$

Note:The unguaranteed residual value is not subtracted when depreciating the leased

asset.

The lessor sets the annual rental payment as follows:

The fair value of the leased asset to the lessor Less: Present value of unguaranteed residual value $7,000 X .62092 (present value of 1 at 10% for 5 periods	$80,000.00 4,346.44
Amount to be recovered through lease payments	$75,653.56
Five periodic lease payments	$18,142.95

Calculation of five lease payments

$$\begin{gathered} \text{Five}\text{lease}\text{payments =}\frac{\text{Amount}\text{recovered}\text{through}\text{lease}\text{payments}}{\text{Present}\text{value}\text{annuity}} \\ =\frac{\$75,653.56}{4.16986} \\ =\$18,142.95 \end{gathered}$$

Note: Present value of an annuity due of 1 for 5 periods at 10%.

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