Question

Peters Company leased a machine from Johnson Corporation on January 1, 2021. The machine has a fair value of $22,000,000. The lease agreement calls for five equal payments at the end of each year. The useful life of the machine was expected to be five years with no residual value. The appropriate interest rate for this lease is 12%.

Other information:

PV of an ordinary annuity @12% for 5 periods: 3.60478
PV of an annuity due @12% for 5 periods: 4.03735

Required:
1. Determine the amount of each lease payment.
2. Prepare the journal entry for Peters Company at the beginning of the lease.
3. Prepare the journal entry for the first lease payment (ignore amortization).
4. Prepare the journal entry for the second lease payment (ignore amortization).

Answer 1

1. Determine the amount of each lease payment.

Lease payment = Fair value / PV of an ordinary annuity @12% for 5 periods = 22,000,000 / 3.60478 = $ 6,103,008

2. Prepare the journal entry for Peters Company at the beginning of the lease.

Date	Account titles & explanation	Debit ($)	Credit ($)
1-Jan-21	Lease Asset	22,000,000
	Lease payable		22,000,000

3. Prepare the journal entry for the first lease payment (ignore amortization).

Interest expense for first year = 22,000,000 x 12% =  2,640,000

Lease paid = 6,103,008 - 2,640,000 = 3,463,008

Date	Account titles & explanation	Debit ($)	Credit ($)
31-Dec-21	Interest expense	2,640,000
	Lease payable	3,463,008
	Cash		6,103,008

4. Prepare the journal entry for the second lease payment (ignore amortization).

Lease payable balance ignoring amortization = 22,000,000 - 2,640,000 =   19,360,000

Interest expense for second year = 19,360,000 x 12% = 2,323,200

Lease paid = 6,103,008 - 2,323,200  = 3,779,808

Date	Account titles & explanation	Debit ($)	Credit ($)
31-Dec-22	Interest expense	2,323,200
	Lease payable	3,779,808
	Cash		6,103,008