Question

Lancaster Services, Inc. leased equipment from Phillips Corporation. Phillips completed construction of the machine on January 1, 2018. The lease agreement for the $8 million (fair value and present value of the lease payments) machine specified four equal payments at the end of each year. The useful life of the machine was expected to be four years with no residual value. Phillip's implicit interest rate was 10%.

Required:
1. Prepare the journal entry for Lancaster Services at the beginning of the lease on January 1, 2018.
2. Prepare an amortization schedule for the four-year term of the lease. Round your answers to the nearest whole dollar amounts.
3. Prepare the appropriate journal entries related to the lease on December 31, 2018.
4. Prepare the appropriate journal entries related to the lease on December 31, 2020.

Answer 1

Solution 1:

Fair value of asset = $8,000,000

Annual lease payment = $8,000,000 / cumulative PV factor at 10% for 4 periods

= $8,000,000 / 3.169865 = $2,523,766

Journal Entries - Lancaster Services
Date	Particulars	Debit	Credit
1-Jan-18	Leased Asset Dr	$8,000,000.00
	To Lease liability		$8,000,000.00
	(To record asset acquired on lease)

Solution 2:

Lancaster Services
Lease Amortization Schedule
Date	Annual lease payment	Interest on liability	Reduction of lease liability	Lease liability
1-Jan-18				$8,000,000
31-Dec-18	$2,523,766	$800,000	$1,723,766	$6,276,234
31-Dec-19	$2,523,766	$627,623	$1,896,143	$4,380,091
31-Dec-20	$2,523,766	$438,009	$2,085,757	$2,294,335
31-Dec-21	$2,523,766	$229,431	$2,294,335	$0

Solution 3:

Journal Entries - Lancaster Services
Date	Particulars	Debit	Credit
31-Dec-18	Interest expense Dr	$800,000.00
	Lease liability Dr	$1,723,766.00
	To Cash		$2,523,766.00
	(To record lease payment)
31-Dec-18	Depreciation expense Dr ($8,000,000/4)	$2,000,000.00
	To Accumulated depreciation - Leased Equipment		$2,000,000.00
	(To record depreciation expense)

Solution 4:

Journal Entries - Lancaster Services
Date	Particulars	Debit	Credit
31-Dec-20	Interest expense Dr	$438,009.00
	Lease liability Dr	$2,085,757.00
	To Cash		$2,523,766.00
	(To record lease payment)
31-Dec-20	Depreciation expense Dr ($8,000,000/4)	$2,000,000.00
	To Accumulated depreciation - Leased Equipment		$2,000,000.00
	(To record depreciation expense)