Question

Pronghorn Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2020. Annual rental payments of $43,000 are to be made at the beginning of each lease year (December 31). The interest rate used by the lessor in setting the payment schedule is 7%; Pronghorn’s incremental borrowing rate is 9%. Pronghorn is unaware of the rate being used by the lessor. At the end of the lease, Pronghorn has the option to buy the equipment for $5,000, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Pronghorn uses the straight-line method of depreciation on similar owned equipment

- Prepare the journal entries, that Pronghorn should record on December 31, 2020

- Prepare the journal entries, that Pronghorn should record on December 31, 2021

- Prepare the journal entries, that Pronghorn should record on December 31, 2022.

- What amounts would appear on Pronghorn’s December 31, 2022, balance sheet relative to the lease arrangement?

Answer 1

Date	Accounts Title	Debit	Credit
Dec, 31 2020	Interest Expense	17,607
	Lease Liability		17,607
Dec, 31 2021	Interest Expense	15,321
	Lease Liability		15,321
Dec, 31 2021	Interest Expense	12,830
	Lease Liability		12,830

$155,388 would appear on Pronghorn’s December 31, 2022, balance sheet relative to the lease arrangement.

(outstanding as on Dec 31, 2022 + Interest for 2022)

Working notes:

Calculation of lease asset value:

Year	Payment made	Discounting factor @ 9%	Present value
2020	43,000	1.000000	43,000
2021	43,000	0.917431	39,450
2022	43,000	0.841680	36,192
2023	43,000	0.772183	33,204
2024	43,000	0.708425	30,462
2025	43,000	0.649931	27,947
2026	43,000	0.596267	25,639
2026 end	5,000	0.547034	2,735
Assets Net Value			238,630

Interest Expense accounting:

Year	Amount at start of year	Payment made	Outstanding	Interest expense in the year
2020	238,630	43,000	195,630	17,607
2021	213,237	43,000	170,237	15,321
2022	185,558	43,000	142,558	12,830
2023	155,388	43,000	112,388	10,115
2024	122,503	43,000	79,503	7,155
2025	86,658	43,000	43,658	3,929
2026	47,588	43,000	4,588	413