Question

Adden Company signs a lease agreement dated January 1, 2016, that provides for it to lease heavy equipment from Scott Rental Company beginning January 1, 2016. The lease terms, provisions, and related events are as follows: 1. The lease term is 4 years. The lease is noncancelable and requires annual rental payments of $20,000 to be paid in advance at the beginning of each year. 2. The cost, and also fair value, of the heavy equipment to Scott at the inception of the lease is $68,036.62. The equipment has an estimated life of 4 years and has a zero estimated residual value at the end of this time. 3. Adden agrees to pay all executory costs. 4. The lease contains no renewal or bargain purchase option. 5. Scott’s interest rate implicit in the lease is 12%. Adden is aware of this rate, which is equal to its borrowing rate. 6. Adden uses the straight-line method to record depreciation on similar equipment. 7. Executory costs paid at the end of the year by Adden are: 2016 2017 Insurance, $1,500 Insurance, $1,300 Property taxes, $6,000 Property taxes, $5,500 Required: 1. Next Level Examine and evaluate each capitalization criteria and determine what type of lease this is for Adden. 2. Prepare a table summarizing the lease payments and interest expense for Adden. 3. Prepare journal entries for Adden for the years 2016 and 2017.

Answer 1

1)

(*) Examine and evaluate each capitalization criteria and determine what type of lease this is for Adden.

Determine what type of lease this is for Adden.

Criteria                                                                                                                                 Met

Transfer of ownership No

Bargain purchase option No         

Lease term is 75% or more of economic life Yes

Present value of lease payments is 90% or more of fair value Yes

(*) Determine what type of lease this is for Adden.

Capital lease

NOTE

For a lease to be treated as a capital lease, the lessee must obtain substantially all the risks and benefits of the asset. GAAP has adapted Capitalization criteria to determine if a lease is considered to have transferred the substantial risks and benefits of ownership. If the lease is not considered a capital lease, it is an operating lease in which the lessee simply recognizes rent expense each period.

2)

(*)Prepare a table summarizing the lease payments and interest expense for Adden.

Date	Annual lease payment	Interest @12% on unpaid obligation	Balance of capital lease obligation
Jan,1,2016-before the initial payment			68036.62
Jan,1,2016	20000.00	0.00	48036.62
Dec,31,2016	0.00	5764.39	53801.01
Jan,1,2017	20000.00	0.00	33801.01
Dec,31,2017	0.00	4056.12	37857.13
Jan,1,2018	20000.00	0.00	17857.13
Dec,31,2018	0.00	2142.87	20000.00
Jan,1,2019	20000	0.00	0.00

NOTE

(*) The capital lease obligation is reduced by the lease payments and increased by the accrued interest for the previous year.

3)

(*)Prepare journal entries for Adden for the years 2016 and 2017.

GENERAL JOURNAL -Jan-2016
DATE	ACCOUNT TITTLE	POST.REF	DR.	CR
Jan.01	Leased Equipment		68063.62
	capital lease obligation			68063.62
Jan.01	capital lease obligation		20000.00
	Cash			20000.00
Dec.31	Interest Expenses		5764.39
	Accrude Interest			5764.39
Dec.31	Executory cost		7500.00
	Cash			7500.00
Dec.31	Depreciation Exp.		17009.16
	Accumulated depreciation			17009.16

NOTE

Use the summary of lease payments and interest expense schedule to determine amounts for entries.

GENERAL JOURNAL -Jan-2017
DATE	ACCOUNT TITTLE	POST.REF	DR.	CR
Jan.01	Accrude Interest on capital lease obligation		5764.39
	capital lease obligation		14235.61
	Cash			20000.00
Dec.31	Interest Expenses		4056.12
	Accrude Interest on capital lease obligation			4056.12
Dec.31	Executory cost		6800.00
	Cash			6800.00
			17009.16
Dec.31	Depreciation Exp.			17009.16
	Accumulated depreciation

NOTE

Use the summary of lease payments and interest expense schedule to determine amounts for entries.