Question

Lessee enters into a three-year lease of equipment and concludes that the agreement is a finance lease because the lease term is for a major part of the remaining economic life of the underlying asset (also three years). In addition, Lessee pays initial direct costs of $3,000. Also, assume that Lessee has guaranteed the residual value of the equipment at the end of the lease term, has concluded that it is probable that Lessee will owe $6,000 to Lessor as a result of that residual value guarantee. The arrangement provides the following:

Lease term	Three years
Annual payments, beginning at the end of year one and annually thereafter	Year 1 – $20,000 Year 2 – $24,000 Year 3 – $28,000
Discount rate	4.235%
PV of lease payments	$66,000

• Complete the following schedule to show the impact on the income statement and balance sheet.

	Initial	Year 1	Year 2	Year 3
Cash lease payments
Cash payments for initial direct costs
Income statement:
Lease expense recognized:
Interest expense
Amortization expense
Total periodic expense
Balance sheet:
ROU asset (including unamortized initial direct costs)
Lease liability

• Prepare the journal entries at the time of the lease commencement and for Year 1 of the lease term.

Answer 1