Question

24. On 01-01-15, Z leased a machine with a useful life of 5 years. The noncancelable lease agreement required Z to make 4 annual lease payments of $25,000 starting 12-31-15. After making the last lease payment, Z will retain the machine. Z’s borrowing rate on 01-01-15 was 4%. Z uses a straight-line depreciation method (no residual value) and only prepares AJEs every December 31. Determine if this is a short-term or a long-term lease. If it is a long-term lease, determine if it is a long-term finance lease or a long-term operating lease. Prepare the lease-related entries Z should make on:

1. 01-01-15
2. 12-31-15
3. 12-31-16
4. 12-31-17
5. 12-31-18
6. 12-31-19

Answer 1

Classification of lease
It is classified as a long term finance lease, as at the end of 4th year Z will retain the asset.

Initial recognition of lease liability and asset
Year	Lease Payment	Discount Factor (4%)	Present Value
1	$        25,000.00	0.9615	$      24,038.46
2	$        25,000.00	0.9246	$      23,113.91
3	$        25,000.00	0.8890	$      22,224.91
4	$        25,000.00	0.8548	$      21,370.10
			$      90,747.38

Journal Entries
Date	Particulars	Debit	Credit
01-01-2015	Asset	$ 90,747.38
	Lease Liability		$ 90,747.38
31-12-2015	Interest Expense	$    3,629.90
	Lease Liability		$    3,629.90
31-12-2015	Lease Liability	$ 25,000.00
	Bank		$ 25,000.00
31-12-2015	Depreciation	$ 18,149.48
	Asset		$ 18,149.48
31-12-2016	Interest Expense	$    2,775.09
	Lease Liability		$    2,775.09
31-12-2016	Lease Liability	$ 25,000.00
	Bank		$ 25,000.00
31-12-2016	Depreciation	$ 18,149.48
	Asset		$ 18,149.48
31-12-2017	Interest Expense	$    1,886.10
	Lease Liability		$    1,886.10
31-12-2017	Lease Liability	$ 25,000.00
	Bank		$ 25,000.00
31-12-2017	Depreciation	$ 18,149.48
	Asset		$ 18,149.48
31-12-2018	Interest Expense	$       961.54
	Lease Liability		$        961.54
31-12-2018	Lease Liability	$ 25,000.00
	Bank		$ 25,000.00
31-12-2018	Depreciation	$ 18,149.48
	Asset		$ 18,149.48
31-12-2019	Depreciation	$ 18,149.48
	Asset		$ 18,149.48