Question

Accounting for Leases
On January 3, 2017, Hanna Corporation signed a lease on a machine for its manufacturing operation. The lease requires Hanna to make six annual lease payments of $12,000 with the first payment due December 31, 2017. Hanna could have financed the machine by borrowing the purchase price at an interest rate of 7%.

a. Prepare the journal entries that Hanna Corporation would make on January 3 and December 31, 2017, to record this lease assuming its i. an operating lease and ii. a capital lease.

Round answers to the nearest whole number. If no entry is required, select "No entry" from the drop-down answer options for the debit and credit entries.

i. the lease is reported as an operating lease.

General Journal
Date	Description	Debit	Credit
Jan. 3	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	To record inception of lease
Dec. 31	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	To record depreciation expense.
Dec. 31	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	To record payment on lease.

ii. the lease is reported as a capital lease.

General Journal
Date	Description	Debit	Credit
Jan. 3	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	To record inception of lease
Dec. 31	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	To record depreciation expense.
Dec. 31	AnswerNo EntryRent expenseCashLeased assetLease liabilityDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	AnswerNo EntryRent expenseCashLeased assetPrepaid rentDepreciation expenseAccumulated depreciationInterest expense	Answer	Answer
	Cash	Answer	Answer
	To record payment on lease.

b. Assuming that the lease is treated as a capital lease, post the journal entries of part a to the appropriate T-accounts.

Cash
	Answer	Answer

Lease Liability
	Answer	Answer

Leased Asset
	Answer	Answer

Accumulated Depreciation
	Answer	Answer

Interest Expense
	Answer	Answer

Depreciation Expense
	Answer	Answer

c. Show how the entries posted in part b would affect the financial statements using the financial statement effects template.

Balance Sheet Transaction Cash Asset + Noncash Assets - Contra Asset = Liabilities + Contrib. Capital + Earned Capital 1. Signed a capital lease. $Answer + $Answer - $Answer = $Answer + $Answer + $Answer 2. Depreciation on leased asset. Answer + Answer - Answer = Answer + Answer + Answer 3. Made annual lease payment Answer + Answer - Answer = Answer + Answer + Answer

Income Statement Revenue - Expenses = Net Income $Answer - $Answer = $Answer Answer - Answer = Answer Answer - Answer = Answer

Answer 1

a.Operating lease:

i.December 31 2017:Rent expense debit 2,000

To Lessor Account-Operating Lease Rental Payable 2,000

(To record rent expense for the year in books-12,000/6)

ii.Lessor Account-Operating Lease Rental Payable Debit 2,000

To Cash account 2,000

(To record lease rental payment made in accordance with the lease agreement)

b.Capital Lease :

i.January 3, 2017 : Leased Asset debit 12,000

To Lease liability 12,000

ii.December 31 2017:Lease rent debit 2,000

To Cash account 2,000

iii.December 31 2017: Accumulated Depreciation debit 2,000

To Depreciation expense 2,000

iv.December 31 2017 : Interest expense Debit 840

To Cash account 840

b.T Accounts

Cash Account

Debit Amount Credit Amount

By Lease rent 2,000

By Interest expense 840

Lease Liability Account

Debit Amount Credit Amount

  By Leased Asset 12,000

Leased Asset Account

Debit Amount Credit Amount

To Lease Liability 12,000

Accumulated depreciation Account

Debit Amount Credit Amount

To depreciation expense 2,000

Depreciation expense Account

Debit Amount Credit Amount

By Accumulated depreciation 2,000

Interest Expense Account

Debit Amount Credit Amount

To Cash account 840

c.Since a capital lease mimics a purchase, you treat the lease payments like the payments you would make if you had bought the asset and financed the cost. That means each lease payment gets separated into principal and interest. If the lease calls for $500-a-month payments, then a particular month's payment might be broken down into, say, $425 in principal and $75 in interest. The "principal" portion goes on your income statement as depreciation expense. The interest portion goes on your income statement as interest expense. The total effect on your net income is the same as with an operating lease: It gets reduced by $500. But while depreciation is an operating expense, interest is not. So your operating income is reduced by only $425.

A capitalized lease increases the total value of the assets on your balance sheet. That affects a number of ratios that creditors, potential investors and others use to evaluate your company's profitability and efficiency. It will reduce your company's return on assets (essentially, the profit it generates for each $1 worth of assets) and its asset turnover (the sales generated for every $1 worth of assets). And since the lease also appears as a liability, it affects measures of financial leverage, such as your liabilities-to-equity ratio. In short, a capitalized lease can make your company's performance look worse, so businesses often structure leases in such a way so they can report them as operating leases.