Question

On January 1, 2021, Rick’s Pawn Shop leased a truck from Corey Motors for a seven-year period with an option to extend the lease for three years. Rick’s had no significant economic incentive as of the beginning of the lease to exercise the 3-year extension option. Annual lease payments are $15,000 due on December 31 of each year, calculated by the lessor using a 4% interest rate. The agreement is considered an operating lease. (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 Rick’s journal entry to record for the right-of-use asset and lease liability at January 1, 2021. 2. Prepare the journal entries to record interest and amortization at December 31, 2021.

Answer 1

Solution:

Since the lease is an OPERATING LEASE, only rental expenses will be recorded. The leased asset will NOT be treated as an asset / liability at the lessee's books. Thus, the entries would be:

Jan 1, 2018 NO ENTRY FOR INCEPTION OF LEASE AS IT IS AN OPERATING LEASE

Dec 31, 2021   Lease rent expense (Debit) $15,000

...............................Cash (Credit) $15,000

Had it been a CAPITAL LEASE instead of operating lease, the entries would be:

Jan 1, 2021 Leased Truck/Asset (Debit) $90,031.5

........................Lease liability (Credit) $90,031.5

Note: $90,031.5 is the present value of the rental payments at 4% discount rate. It can be computed either using the present value of the annuity tables or using the excel function =PV(RATE,NPER,PMT,FV) and substitute it as =PV(4%,7,17000,0).

Note: Usually lease payments begin from the date of inception and hence considered as annuity dues. But in this case since the lease payments are due only every December end, it is considered as an ordinary annuity. This amount will differ if it is assumed as annuity due.

.

Dec 31, 2021  Lease interest ($90,031.5 * 4%) (Debit) $3,601.26 (This is interest portion)

..........................Lease liability (15000-3680) (Debit) $11,398.74 (This is amortization portion)

.............................................................Cash (Credit)    $15,000