Question

Timmer Company signs a lease agreement dated January 1, 2016, that provides for it to lease equipment from Landau Company beginning January 1, 2016. The lease terms, provisions, and related events are as follows:

•	The lease is noncancelable and has a term of 5 years.
•	The annual rentals are $83,222.92, payable at the end of each year, and provide Landau with a 12% annual rate of return on its net investment.
•	Timmer agrees to pay all executory costs at the end of each year. In 2016, these were insurance, $3,760; property taxes, $5,440. In 2017: insurance, $3,100; property taxes, $5,330.
•	There is no renewal or bargain purchase option.

Timmer estimates that the equipment has a fair value of $300,000, an economic life of 5 years, and a zero residual value. Timmer’s incremental borrowing rate is 16%, it knows the rate implicit in the lease, and it uses the straightline method to record depreciation on similar equipment.

Required:

1.	Calculate the amount of the asset and liability of Timmer at the inception of the lease.
2.	Prepare a table summarizing the lease payments and interest expense.
3.	Prepare journal entries on the books of Timmer for 2016 and 2017.
4.	Next Level Prepare a partial balance sheet in regard to the lease for Timmer for December 31, 2016. Use the change in present value approach to classify the capital lease obligation between current and noncurrent.

Answer 1

1) Calculation of the amount of the Asset and Liability of Timmer at the Inception of the lease:

Given Annual Rentals = $83222.92

Annual Rate of Return = 12%

Year	Annual Rent	Present Value Factor @ 12%	Calculation for Present Value Factor	Closing Value (annual rent * Present value factor)
1	83222.92	0.89286	1/1.12 =0.89286	74306.416
2	83222.92	0.79719	(1/1.12)^2	66344.479
3	83222.92	0.71178	(1/1.12)^3	59236.410
4	83222.92	0.63552	(1/1.12)^4	52889.830
5	83222.92	0.56743	(1/1.12)^5	47223.181
Total		300000 (Rounded)

2) Summarizing Lease Payments and Interest Expense:

(a)	(b)	(c)	(d)	(e)
Date	Annual Lease Payment	Interest Expense@12% (c) = (e)*12%	Excess lease payment over Interest (d) = (b) – (c)	Closing Obligation ($) (e) = opening bal – (d)
1 jan 2016	Opening Balance		300000
31- Dec -16	83222.92	36000.00	47222.92	252777.08
31- Dec -17	83222.92	30333.25	52889.67	199887.41
31- Dec -18	83222.92	23986.49	59236.43	140650.98
31- Dec -19	83222.92	16878.12	66344.80	74306.18
31- Dec -20	83222.92	8916.74	74306.18	0.00

3) journal entries in the books of Timmer for the year 2016 and 2017

Date	Particulars	Debit ($)	Credit ($)
1 jan 2016	Leased Equipment	300000
	To lease Liability		300000
31 dec 2016	Interest expense	36000
	Lease Liability	47222.92
	To cash		83222.92
31 dec 2016	Insurance Expense	3760
	Property Tax Expense	5440
	To Cash		9200
31 dec 2016	Depreciation (W.N)	60000
	To Leased Equipment		60000

31 dec 2017	Interest expense	30333.25
	Lease Liability	52889.67
	To cash		83222.92
31 dec 2017	Insurance Expense	3100
	Property Tax Expense	5330
	To Cash		8430
31 dec 2017	Depreciation (W.N)	60000
	To Leased Equipment		60000

Working Note (W.N)

Given useful life =5 years

           Residual Value = 0

          Method Of depreciation = straight line

Depreciation = (300000-0) / 5 years

                         = $ 60000

4) Extract of balance sheet in the books of timmer for the year end 2016

Balance sheet extract of Timmer as on 31 dec 2016

Liabilities	Amount ($)
Current Liabilities	52889.67
Non Current Liabilities	199887.41

Note : If you have any doubts please comment. Thank you