Question

2016, ABC Company leased a copier from XYZ. The three-year lease agreement specifies annual payments of $50,000 beginning January 1, 2016, the inception of the lease, and at each January 1 thereafter through 2018. The useful life of the copier is estimated to be ten years. Before deciding to lease, ABC considered purchasing the copier for its cash price of $230,000. If funds were borrowed to buy the copier, the interest rate would have been 8%. ABC Company paid a commission of $4,000 to arrange this lease.

a) How would this lease be classified by the lessee? Be specific and provide supporting computations.

b) Prepare the journal entry to record the lease on January 1, 2016. Provide supporting computations.

c) Prepare the journal entry required on December 31, 2016. Provide supporting computations

d) Prepare the entries required in 2017 and 2018 related to this lease. Provide supporting computations

Answer 1

a. This lease is classified as operating lease because the criteria for selecting it as capital lease is not met.

Capital lease criteria:		Status
Ownership transfers at the end of the lease		Not met
Written option for bargain purchase		Not met
Present value of lease payments >= 90% of the fair value of the leased property		Not met
The lease term is >=75% of the assets economic life		Not met

Economic life of property	10 years
75% of above	7.5 years
Lease term	3 years
Is criteria met	Not met

	Present value of lease payments:
	Present value of annuity=	P* [ [1- (1+r)-n ]/r ] +P
P=	Periodic payment	50,000
r=	Rate of interest per period	8.00%
n=	number of periods:
	Number of years	2
	payments per year	1
	number of periods	2
	Present value of annuity=	50000* [ (1- (1+0.08)^-2)/0.08 ] + 50000
	Present value =	1,39,163.24
	Fair value of leased property	2,30,000.00
	90% of fair value	2,07,000.00
	Is present value greater than 90% of fair value of property	False
	Criterial met or not met	Not met

b.

Date	Account	Debit	Credit
Jan.1	commission expense	4000
	prepaid lease expense	50000
	cash		54000

c.

Date	Account	Debit	Credit
Dec.31	rent expense	50000
	prepaid lease expense		50000

d.

2017
Date	Account	Debit	Credit
Jan.1	prepaid lease expense	50000
	cash		50000
Date	Account	Debit	Credit
Dec.31	rent expense	50000
	prepaid lease expense		50000
2018
Date	Account	Debit	Credit
Jan.1	prepaid lease expense	50000
	cash		50000
Date	Account	Debit	Credit
Dec.31	rent expense	50000
	prepaid lease expense		50000