Question

Problem 21A-6 b-f (Part Level Submission)

Stellar Leasing Company agrees to lease equipment to Pearl Corporation on January 1, 2017. The following information relates to the lease agreement. 1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. 2. The cost of the machinery is $520,000, and the fair value of the asset on January 1, 2017, is $737,000. 3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $110,000. Pearl estimates that the expected residual value at the end of the lease term will be 110,000. Pearl amortizes all of its leased equipment on a straight-line basis. 4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. 5. The collectibility of the lease payments is probable. 6. Stellar desires a 10% rate of return on its investments. Pearl’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.)

Prepare the journal entries Pearl would make in 2017 and 2018 related to the lease arrangement. (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. 58,972.) Date Account Titles and Explanation Debit Credit 1//1/17 664702 Lease Liability 664702 (To record the lease.) Lease Liability 127081 Cash 127081 (To record lease payment.) 12/31/17 (To record amortization.) (To record interest.) 1/1/18 Lease Liability 127081 Cash 127081 12/31/18 (To record amortization.) (To record interest.)

Answer 1

Date	Account Titles and Explanation	Debit	Credit
1//1/17	Lease Asset	717685
	Lease Liability		717685
	(To record the lease.)
	Lease Liability	127081
	Cash		127081
	(To record lease payment.)
12/31/17	Depreciation Exp	86812
	Accumulated Dep (717685 - 110000) / 7		86812
	(To record amortization.)
	Interest Expense	64966
	Interest Payable		64966
	(To record interest.)
1/1/18	Interest payable	64966
	Lease Liability	62115
	Cash		127081
12/31/18	Depreciation Exp	86812
	Accumulated Dep		86812
	(To record amortization.)
	Interest Expense	58134
	Interest Payable		58134
	(To record interest.)

Annual rental payment = $737,000 – ($110,000 X .51316)* / 5.35526** = 127081

*Present value of $1 at 10% for 7 periods.

**Present value of an annuity due at 10% for 7 periods

Present value of minimum lease payments: 717685

PV of annual payments: $127,081 X 5.23054** = 664702.8

+PV of guaranteed residual value:$110,000 X   .48166** = 52982.6

*Present value of an annuity due at 11% for 7 periods

**Present value of $1 at 11% for 7 periods

Interest payable = ( $ 717685 - 127081 ) * 0.11 = 64966

12/31/18

Interest payable = ( $ 717685 - 127081 - 62115 ) * 0.11 = 58134