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Question: Lessee Entries; Capital Lease with Unguaranteed Residual Value) On January 1, 2017, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of \(8,668 at the beginning of each year, starting January 1, 2017. The machine has an estimated useful life of 6 years and a \)5,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke’s incremental borrowing rate is 10%, and the lessor’s implicit rate is unknown.

Instructions

(c) Prepare all necessary journal entries for Burke for this lease through January 1, 2018.

Step by step solution

01

Meaning of Capital Lease

A capital lease is one that gives the lessee all the rights that come with ownership of the asset while payments are still being made. A capital lease is a type of finance. It is a long-term lease that is neither reversible nor cancelable.

02

Preparing Journal Entries for Burke for this lease through January 1, 2018

Date	Particular	Debit ($)	Credit ($)
January 1, 2017	Leased Equipment	36,144
	Lease Liability		36,144
January 1, 2017	Lease Liability	36,144
	Cash		36,144
December 31, 2017	Depreciation Expense	7,229
	Accumulated Depreciation Capital Leases		7,229
December 31, 2017	Interest Expense	2,748
	Interest Payable		2,748
January 1, 2018	Lease Liability	5,920
	Interest Payable	2,748
	Cash		8,668

Working Notes:

Calculation of Accumulated Depreciation Capital Leases

$$\begin{gathered} \mathbf{\text{AccumulatedDepreciation=}}\frac{\mathbf{L}\mathbf{e}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{d}\mathbf{}\mathbf{E}\mathbf{q}\mathbf{u}\mathbf{i}\mathbf{p}\mathbf{m}\mathbf{e}\mathbf{n}\mathbf{t}}{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{}\mathbf{l}\mathbf{e}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{}\mathbf{y}\mathbf{e}\mathbf{a}\mathbf{r}} \\ \mathbf{\text{=}}\frac{\mathbf{\$}\mathbf{36}\mathbf{,}\mathbf{144}}{\mathbf{5}} \\ \mathbf{\text{=\$7,229}} \end{gathered}$$

Calculation of Interest payable amount

$$\begin{gathered} \mathbf{Interest}\mathbf{}\mathbf{payable}\mathbf{=}\left(\mathrm{Leased}\mathrm{Equipment}-\mathrm{Lease}\mathrm{liablity}\right)\mathbf{×}\mathbf{Incremental}\mathbf{}\mathbf{borrowing}\mathbf{}\mathbf{rate} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\left(\$36,144-\$8,668\right)\mathbf{×}\mathbf{10}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{276}\mathbf{,}\mathbf{476}\mathbf{×}\frac{\mathbf{10}}{\mathbf{100}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{448} \end{gathered}$$

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