Question

A lessor and a lessee signed a lease agreement that qualifies as a finance/sales-type lease and calls for annual lease payments of $26,269 over a six-year lease term. The asset's estimated useful life is also six years. The first payment is due on January 1st, which is the beginning of the lease. The interest rate is 5%. Based on these facts, the present value of the lease payments (which are equal to the value of the asset to the lessor) has been determined to be $140,000.

Required:

[1] For both the lessor and the lessee, prepare the journal entries necessary at the time of lease signing.

[2] For both the lessor and the lessee, prepare the journal entries necessary at the first lease payment (January 1st).

[3] For both the lessor and the lessee, prepare the journal entries necessary at the second lease payment (December 31st).

[4] For the lessee, only, prepare the entry necessary to "depreciate" the right-of-use asset (hint: depreciation under a finance lease is referred to as amortization).

[5] Why doesn't the lessor have to depreciate the asset?

Answer 1

In the qiven instance, lease qualifies as financial lease. In financial lease lessee has the right to buy the leased asset at the end of the lease period and charge depreciation for the leased asset over lease period. Value of leased asset shall be equal to fair value of leased asset at the inception of lease ie, present value of minimum lease payment.Therefor journal entries are as follows :-

  

At the end of 31 st december of first year of lease, Annual lease payment shall include principal amount and interest on lease. Therefore both lessor and lesse has to pass entries for booking interest and charging or crediting the same to Profit and Loss account respectively aong with second installment payment.

Interest is charges at 5%. In the first installment payment shall not include interest payment being it has paid before lease period begins. Interest will be charged on balance outstanding after payment of first installment from value of leased asset ie,$ 1,40,000/-.

Interest charged = (140000 - 26269)* 5% = $ 5687/-

Being lease is a financial lease lessee is eligible to claim depreciation of leased asset over the leased asset. For computing depreciation amount no rate of depreciation and salvage value have given. Therefore it shall assumed that depreciation is to be charged on straight line method for the six year by amortising entire value of leased asset.Here answer is given on SLM basis depreciation ie, $140000/6 = $ 23,333 per year . This amount will change if we go for WDV method of depreciation.

Q,No (4)

In the financial lease, Lessor will transfer all significant and risk and reward associated with asset to lessee.Lessee has the right to buy the leased asset at the end of lease period.Lease period shall cover most of useful life of leased asset.therefore, lessee is eligible to claim depreciation over the period lease agreemnet. lessor will account the lease as lease sales at the beginning of lease considering substance over form concpet. Therefore, Lessor is not eligible for depreciation.