Question

Cullumber Company, as lessee, enters into a lease agreement on July 1, 2021, for equipment. The following data are relevant to the lease agreement:

1.		The term of the noncancelable lease is 4 years, with no renewal option. Payments of $855,212 are due on July 1 of each year.
2.		The fair value of the equipment on July 1, 2021 is $3,020,000. The equipment has an economic life of 6 years with no salvage value.
3.		Cullumber depreciates similar machinery it owns on the sum-of-the-years'-digits basis.
4.		The lessee pays all executory costs.
5.		Cullumber's incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 9% in computing the lease payments.

Indicate the type of lease Cullumber Company has entered into and what accounting treatment is applicable. (finance or lease method)

Prepare the journal entries on Cullumber's books that relate to the lease agreement for the following dates: (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 5,250.)

1.		July 1, 2021.
2.		December 31, 2021.
3.		July 1, 2022.
4.		December 31, 2022

Answer 1

(A) Capitalized amount:

$855,212 * PV of an ordinary annuity for 4 periods at 8%

= $855212 * 3.53129 = $3,020,000

Because the present value of the lease payments ($3,020,000) equals the fair value,$3,020,000, of the leased property, it is a capital lease and must be accounted for under the capital lease method.

Date	Account titles adn Explanation	Debit ($)	Credit ($)
July 1, 2021	Leased Equipment Under Capital Leases	$ 30,20,000.00
	Lease Liability		$ 30,20,000.00
			.
Dec.31, 2021	Depreciation Expense [($3,020,000 *4/10)* 6/12]	$   6,04,000.00
	Accumulated Depreciation- Capital Leases		$    6,04,000.00
	Interest Expense ($3,020,000*9%*6/12)	$   1,35,900.00
	Interest Payable		$    1,35,900.00
July 1 ,2022	Interest Expense (3020000*9%)	$   2,71,800.00
	Lease Liability	$   5,83,412.00
	Cash		$    8,55,212.00
Dec.31,2022	Depreciation Expense	$ 10,57,000.00
	Accumulated Depreciation- Capital Leases		$ 10,57,000.00
	[($3,020,000 *4/10)* 6/12] + [($3,020,000 *3/10)* 6/12]
	Interest Expense (219,293 * 6/12)	$   1,09,646.46
	Interest Payable		$    1,09,646.46
Lease Amortization Schedule-
Date	Anuual lease payment	Interest on unpaid obligation	Reduction of lease obligation	Balance of lease obligation
07-01-2021				$30,20,000.00
6/30/22	$ 8,55,212.00	$   2,71,800.00	$    5,83,412.00	$24,36,588.00
6/30/23	$ 8,55,212.00	$   2,19,292.92	$    6,35,919.08	$18,00,668.92