Question

On January 1, 2021, Kiki Co. leased machinery from Jiji Co. Presented below is selected information about the non-cancelable lease agreement, the leased equipment, and the parties to the lease.

• Kiki borrows at 5% and is unable to determine that Jiji’s implicit rate is 4%.

• Jiji paid $90,000 for the machine and at the inception of the lease, its fair value is $120,000.

• The machine has a $7,000 residual value, none of which is guaranteed, and an estimated 5-year life.

• The lease requires beginning-of-year rental payments over its 3-year term, i.e., rentals are due every January 1 and the lease ends December 31, 2023.

Required—Prepare all lease-related journal entries that Kiki should record over the three-year lease, supported by an appropriate amortization schedule.

Answer 1

Answer:

Where the lessee is unable to readily determine the interest rate implicit in the lease, the discount rate will be the lessee's incremental borrowing rate.

Hence discount rate will be 5%.

Annual lease payment = FMV of asset / 2.85941 = $120,000 / 2.85941 = $41,967

Date	General Journal	Debit	Credit
Jan.01, 2021	Leased machine	$      120,000
	Lease liability		$     120,000
Jan.01, 2021	Lease liability	41,967
	Cash		41,967
Dec.31, 2021	Depreciation expense	24,000
	Accumulated depreciation-Capital lease		24,000
Jan.01, 2022	Lease liability	38,065
	Interest expense	3,902
	Cash		41,967
Dec.31, 2022	Depreciation expense	24,000
	Accumulated depreciation-Capital lease		24,000
Dec.31, 2023	Lease liability	39,968
	Interest expense	1,999
	Cash		41,967
Dec.31, 2023	Depreciation expense	24,000
	Accumulated depreciation-Capital lease		24,000

LEASE AMORTIZATION SCHEDULE
Year	Opg Bal.	Lease Rent	Interest Exp	Reduction in O/s Liab	Closing Bal.
(1)	(2)	(3)	(4) = (2) × 5%	(5) = (3) - (4)	(6) = (2) - (5)
Jan.01, 2021	$            120,000	$            41,967		$                       41,967	$              78,033
Jan.01, 2022	$              78,033	$            41,967	$                3,902	$                       38,065	$              39,968
Dec.31, 2023	$              39,968	$            41,967	$                1,999	$                       39,968	$                       (0)