Question

1. Lessee enters into a four-year lease of equipment and concludes that the agreement is a finance lease because the lease contains an option for Lessee to purchase the equipment at the end of the lease and the Lessee is reasonably certain to exercise that option. The arrangement provides the following:

Lease term	Four years, with the first payment due at lease commencement and the remainder annually at the lease anniversary date thereafter
Annual payments, beginning at lease commencement and annually thereafter	Commencement – $50,000 Year 2 – $53,000 Year 3 – $55,000 Year 4 -- $60,000
Discount rate	4.5%
PV of lease payments	$204,577

Complete the following schedule to show the impact on the income statement and balance sheet.

	Initial	Year 1	Year 2	Year 3	Year 4
Cash lease payments
Income statement:
Lease expense recognized:
Interest expense
Amortization expense
Total periodic expense
Balance sheet:
ROU asset
Lease liability

• Prepare the journal entries at the time of the lease commencement and for Year 1 of the lease term.

Answer 1

	Sol
	Particulars	Initial	Year 1	Year 2	Year 3	Year 4
	Cash lease payments	$   50,000.00		$   50,717.70	$                 50,365.15	$ 52,577.80
	Income statement:
	Lease expense recognized:
	Interest expense		$     2,282.29	$     4,634.85	$                   7,422.20
	Amortization expense		$   50,915.00	$   50,915.00	$                 50,915.00	$ 50,915.00
	Total periodic expense	$                -	$   53,197.29	$   55,549.85	$                 58,337.20	$ 50,915.00
	Balance sheet:
	ROU asset	$ 203,661.00	$ 152,745.75	$ 101,830.50	$                 50,915.25	$              -
	Lease liability	$ 203,660.65	$ 153,660.65	$ 102,942.94	$                 52,577.80	$              -
	Initially
	ROU Asset A/c       Dr	$ 203,660.65
	To Lease Liability A/c		$ 203,660.65
	Lease Liability A/c Dr	$   50,000.00
	To Bank A/c		$   50,000.00
	Year 1 Lease Term
	Interest Exp A/c   Dr	$     2,282.00
	To Lease Liability		$     2,282.00
	Depreciation A/c     Dr	$   50,915.00
	To ROU Asset A/c		$   50,915.00
	P&L A/c   Dr	$   53,197.00
	To Interest Expense A/c		$     2,282.00
	To Depreciation A/c		$   50,915.00
Working
	Calculation of Cash Payments and Interest Expenses
Year	EMI Payment	Disc Rate	Cash Payments	Interest Expense
Initial	$                            50,000.00	4.50%	$   50,000.00
Year 1	$                            53,000.00	4.50%	$   50,717.70	$     2,282.30	Cash Payments at year beginning
Year 2	$                            55,000.00	4.50%	$   50,365.15	$     4,634.85
Year 3	$                            60,000.00	4.50%	$   52,577.80	$     7,422.20
			$203,660.65	$ 14,339.35
	Depreciation Charged on Straight line methof for 4 Years
	Depreciation = Cost/Life = 203660/4= $50915
	Opening Value of ROU Asset	Amortization	Closing Value
	$                          203,661.00	$   50,915.25	$ 152,745.75
	$                          152,745.75	$   50,915.25	$ 101,830.50
	$                          101,830.50	$   50,915.25	$   50,915.25
	$                            50,915.25	$   50,915.25	$                -