Question

Lessee Company enters into a 6-year finance lease of non-specialized equipment with Lessor Company on January 1, 2020. Lessee has agreed to pay $44,800 annually beginning immediately on January 1, 2020. The lease includes an option for the lessee to purchase the equipment at $4,800, which is $3,200 below the estimated fair value at lease end. Lessee Company is reasonably certain that it will exercise the purchase option. The economic life of the asset is 7 years. The lessee’s incremental borrowing rate is 7% and the lessor’s implicit rate is not readily determinable by the lessee. Record Lessee Company’s journal entries on (a) January 1, 2020, and (b) December 31, 2020, assuming that the lease is properly classified as a finance lease.

Answer 1

	Date	Account titles and explanation	Debit	Credit
	01-Jan-20	ROU asset	$228,489
		Lease payable		$228,489
		(ROU asset and lease payable recorded)
	01-Jan-20	Lease payable	$44,800
		Cash		$44,800
		(first installment of lease paid)
	31-Dec-20	Interest expense	$15,994
		Lease payable	$28,806		(228,489*7%)
		Cash		$44,800
		(lease installemnt paid)
	31-Dec-20	Depreciation expense	$45,698		(228,489/5)
		Accumulated depreciation - ROU asset		$45,698
		(depreciation recorded on ROU asset)
	Calculation of fair value of the ROU asset
	Date	Lease payment	PV factor 7%	Present value
0	01-Jan-20	44800	1	$44,800
1	31-Dec-20	44800	0.93458	$41,869
2	31-Dec-21	44800	0.87344	$39,130
3	31-Dec-22	44800	0.8163	$36,570
4	31-Dec-23	44800	0.7629	$34,178
5	31-Dec-24	44800	0.71299	$31,942
		ROU/Lease payable		$228,489