In: Accounting
On January 1, 2020, Winthrop Inc. entered into a lease agreement to lease equipment:
Required:
Given in question,
Number of periods | 5 |
Incremental borrowing rate | 5% |
Rental payments (beginning of each year) | 10,000 |
a) Present value of the lease payments (Discounted at 5%)
Year | Date | Lease | PVF @ 5% | PV | PVF | |
0 | 1-Jan-20 | 10,000 | 1.00 | 10,000 | t=0 i.e. 1/(1+5%)^0 | |
2 | 31-Dec-21 | 10,000 | 0.91 | 9,070 | t=2 i.e. 1/(1+5%)^2 |
First payment is on January 1, 2020 and the other payments are on 31 December each year |
3 | 31-Dec-22 | 10,000 | 0.86 | 8,638 | t=3 i.e. 1/(1+5%)^3 | |
4 | 31-Dec-23 | 10,000 | 0.82 | 8,227 | t=4 i.e. 1/(1+5%)^4 | |
5 | 31-Dec-24 | 10,000 | 0.78 | 7,835 | t=5 i.e. 1/(1+5%)^5 | |
Lease liability | 43,771 |
Notes for student
Discount Rate for the
Lease
For a lessee, the discount rate for the lease is the rate
implicit in the lease unless that rate cannot be readily
determined. In that case, the lessee is required to use its
incremental borrowing rate.
Incremental Borrowing
Rate
The rate of interest that a lessee would have to pay to borrow on a
collateralized basis over a similar term an amount equal to the
lease payments in a similar economic environment.
b) Lease amortization table
Date | Lease Payment | Interest @ 5% | Principal | Lease Liability |
1-Jan-20 | 43,771 | |||
1-Jan-20 | 10,000 | (10,000) | 33,771 | |
31-Dec-20 |
1,689 [33,771 X 5%] |
- | 35,460 | |
31-Dec-21 | 10,000 |
1,773 [35,460 X 5%] |
(8,227) [1,773 - 10,000] |
27,232 [35,460 - 8,227] |
31-Dec-22 | 10,000 | 1,362 | (8,638) | 18,594 |
31-Dec-23 | 10,000 | 930 | (9,070) | 9,524 |
31-Dec-24 | 10,000 | 476 | (9,524) | - |
c) Classification of lease
This lease is an operating lease for the following reason:
If any one of the above condition was satisfied then the lease would be a finance lease.
d) Journal entries for the lessee for the 2020 fiscal year related to the lease arrangement
Date | Particulars | Dr/Cr | Debit | Credit | |
1-Jan-20 | Right-of-use Asset | Dr | 43,771 | ||
Lease liability | Cr | 43,771 | |||
1-Jan-20 | Lease liability | Dr | 10,000 | ||
Bank | Cr | 10,000 | |||
31-Dec-20 | Lease expense | Dr | 10,000 | In operating lease - Right-of-use asset is not amortized like in finance lease - it is accounted as Lease expnse | |
Lease liability | Cr | 1,689 | From lease amortisation table [Interest of year 1 accrued on 31 December 2020] | ||
Right-of-use Asset | Cr | 8,311 | [Plug variable i.e. 10,000 - 1,689] |