Question

George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is $299,140, and its unguaranteed residual value at the end of the lease term is estimated to be $20,000. National will pay annual payments of $40,000 at the beginning of each year and all maintenance, insurance, and taxes. George incurred costs of $180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.

(b) Prepare a 10-year lease amortization schedule.

(c) Prepare all of the lessee’s journal entries for the first year. Assume straight-line depreciation.

Answer 1

a) As per the information given, since the lease terms for National Airlines fulfill the criteria to be classified as a Capital Lease, of Lease Term being more than 75% of the Useful Life and present value of lease payments cover 90% of the Fair Value of the asset, therefore, it would be classified as a Capital Lease by the Lessee. Under the Capital Lease, Lease Liability and Leased Asset at the inception of the lease are recorded at the present value of the minimum lease payments. Minimum Lease Payments don't include the unguaranteed residual value.

Present Value of Lease Payments = Annual Lease Payment * Present Value Interest Factor of Annuity Due at 10% for 10 periods

= 40,000 * 6.7590

= $270,360

Therefore, National Airlines (Lessee) should record the initial lease liability at $270,360.

b) Lease Amortization Schedule

c)

Date	Particulars	Debit ($)	Credit ($)
Beginning of the Year	Lease Asset	$270,360
	Lease Payable		$270,360
	(Recording of the inception of the lease)
Beginning of the Year	Lease Payable	$40,000
	Cash		$40,000
	(Recording of the payment of first lease payment)
End of the Year	Interest Expense	$23,036
	Interest Payable		$23,036
	(Recording of the accrual of interest on Lease Obligation for the year)
End of the Year	Depreciation Expense	$27,036
	Accumulated Depreciation		$27,036
	(Recording of the Depreciation charged for the year)