Question

American Food Services, Inc., leased a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2018. The lease agreement for the $4.3 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 five years with no residual value. Barton and Barton’s implicit interest rate was 10%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1. Prepare the journal entry for American Food Services at the beginning of the lease on January 1, 2018.

2. Prepare an amortization schedule for the four-year term of the lease.

3. & 4. Prepare the appropriate entries related to the lease on December 31, 2018 and 2020.

Answer 1

Ans.                                          Journal Entry in the books of American Foods Inc.

Jan 1 2018                              Packaging machine A/c   Dr    4300000

                                                       To Barton and Barton Co. A/c           4300000

                                   (Being packaging machine leased from barton and barton co.)

2. Step 1: Calculation of Annual lease payment

Cumulative present value of 4yrs @10% = 3.1699

Annual lease payment = 4300000/3.1699 = 1356510   

                                      Amortization Schedule for the four year term of the lease

Year            Bal. of fair value    Lease payment Interest paid   Principal Balance Amt.

1. 4300000 1356510       430000 926510     3373490

2.     3373490 1356510     337349 1019161 2354329

3. 2354329 1356510 235433    1121077    1233252

4. 1233252 1356510 123258    1233252 0

3.    Journal Entry in the books of American food services

Jan 31 2018    Barton and Barton Co. A/c (lease liability) Dr        926510

   Interest Expenses (4300000X10%) A/c       Dr. 430000

   To Cash/Bank A/c    1356510

   (Payment of lease in the 1st year )

4.                                                Journal Entry in the books of American foods service (Leasee)

12 Dec 2020 Barton and Barton Co (lease liability) A/c    1121077

Finance Charge A/c    233435

                                                               To Cash/Bank A/c                                              1356510

                                      (Being Lease amount is paid in the 3rd year)