Question

On January 1, 2017, Cullumber Company contracts to lease equipment for 5 years, agreeing to make a payment of $140,532 at the beginning of each year, starting January 1, 2017. The leased equipment is to be capitalized at $586,000. The asset is to be amortized on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cullumber’s incremental borrowing rate is 6%, and the implicit rate in the lease is 10%, which is known by Cullumber. Title to the equipment transfers to Cullumber at the end of the lease. The asset has an estimated useful life of 5 years and no residual value.

Prepare the journal entries that Cullumber should record on January 1, 2017.

Prepare the journal entries to record amortization of the leased asset and interest expense for the year 2017.

Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made.

What amounts will appear on the lessee’s December 31, 2017, balance sheet relative to the lease contract? How would the value of the lease liability in part (b) change if Cullumber also agreed to pay the fixed annual insurance on the equipment of $2,000 at the same time as the rental payments?

Answer 1

Journal entry as on 01/01/17:-

Lease Asset A/c Dr –            586,000

To Lease Liability A/c Cr. -    586,000

Journal entries to record interest expense

Lease Liability A/C Dr.                                   126,479

Interest Expense A/c Dr (140532 *10%)        14,053

To Cash A/c Cr                                                  140,532

Journal entries to record amortization (@40%)

Depreciation A/c Dr             234,000

To Lease Asset A/c Cr        234,000