Question

Lessee enters into a three-year lease for retail space and concludes that the agreement is an operating lease. Lessee pays initial direct costs of $3,000.  The agreement 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
Income statement:
Periodic lease expense (straight line)
(Accrued) prepaid rent for period
Balance sheet:
ROU asset:
Lease liability
Adjust: accrued rent (cumulative)
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

	Lessee Accounting:
b	The leasee should use a single accounting model for all type of lease. The lease liability and the ROU asset are measured on the commencement date using the Implicit rate of interest (i.e.,4.235% p.a. in this case)or incremental borrowing rate(if implicit rate is not known) at lease commencement date . The lease liability is accounted for by the interest method subsequently and the ROU asset is subject depreciation on the straight-line basis over the lease term of 3 year.
	The leasee shall record the lease liability and right in use asset at the Present value of Lease payment and guaranteed residual value as calculated below.
	Year	Payments (Cash flows)	Present Value Factor @4.235%p.a.	Discounted Cash flows/ Present value
	1	$                                                   20,000.00	0.959371	$                              19,187		11-01-1900
	2	$                                                   24,000.00	0.920392	$                              22,089
	3	$                                                   28,000.00	0.882997	$                              24,724
	Total	$                                                        72,000		$                              66,000
	01-07-2019	Lease liability	$                    66,000
		Initial direct cost	$                      3,000
		ROU asset	$                    69,000
	Lease Amortisation Schedule:
Beg of year	Annual Lease Payments Plus expected residual value	Interest on lease liability	Reduction of lease Liability	Lease liability
0.00	$                                          -	$                                                                 -	$                             -	$                              66,000
1.00	$                                 20,000	$                                                           2,795	$                    17,205	$                              48,795
2.00	$                                 24,000	$                                                           2,066	$                    21,934	$                              26,861
3.00	$                                 28,000	$                                                           1,139	$                    26,861	$                                       (0)
		In the books of Lessee
c		Journal Entries
	Year	Particulars	Debit	Credit
	1	Right of Use Asset	$                    69,000
		Lease liabilty		$                              66,000
		Cash		$                                3,000
		(To record initially recognise the lease-related asset and liability .)
	1	Lease liabilty	$                    17,205
		Interest expense	$                      2,795
		Cash		$                              20,000
		(To record lease payment)
	1	Depreciation expense	$                    23,000
		Accumulated depn- Right of Use Asset		$                              23,000
		( To record depreciation expense on the ROU asset)
		($69,000/3 year)
			Initial	Year 1	Year 2	Year 3
		Cash lease payments		$                       20,000	$                       24,000	$                       28,000
		Cash payments for initial direct costs	$                 3,000
		Income statement:
		Lease expense recognized:
		Interest expense		$                         2,795	$                         2,066	$                         1,139
		Amortization expense		$                       23,000	$                       23,000	$                       23,000
		Total periodic expense		$                       25,795	$                       25,066	$                       24,138
		Balance sheet:
		ROU asset (including unamortized initial direct costs)	$               69,000	$                       46,000	$                       23,000	$                              -
		Lease liability	$                    66,000	$                              48,795	$                              26,861