Question

On January 1, 2021, Osiris Inc. leased manufacturing equipment from Giza Leasing for a four-year period ending December 31, 2021, at which time possession of the leased asset will revert back to Giza. The equipment cost Giza $206,092 and has an expected economic life of five years. Giza expects the residual value at December 31, 2021, to be $25,000. Negotiations led to Osiris guaranteeing a $35,000 residual value.

Equal payments under the lease are $50,000 and are due on December 31 of each year with the first payment being made on December 31, 2021. Osiris is aware that Giza used a 5% interest rate when calculating lease payments.

Required:

Round your answers to the nearest whole dollar amounts.

1.Prepare the appropriate journal entry for Osiris on January 1, 2021, to record the lease.

2.Prepare all appropriate journal entries for Osiris on December 31, 2021, related to the lease.

Answer 1

In the books of Osiris Inc
Information:
Life of Equipment	5 Years
Lease period	4 Years
cost of equipemnt	206092
Lease rental	50000
Annuity for 4 years @ 5%	3.5459
Present value interest factor @5% for 4th year	0.8229
Depreciation= 206092/4 years	51523

Minimum lease payment(MLP)= Lease rentals+ Guaranteed residual value
Present value of MLP is 206090	(50000*3.5459)+0.8229*35000
A lease is classified as a capital lease when it meets the following criteria as provided
1.Whether the lease provides for the transfer of ownership to the lessee at the end of the lease term.
2.Whether the lessee has the option to purchase the leased asset at a price less than fair market value or say at a bargain price
3.The lease term is greater than or equal to 75% of the asset’s useful economic life;
4.The present value of the lease rental of such a lease is greater than 90% of the asset leased’s fair value at the time of lease.
5. The leased asset is specialized or unique in nature. And such an asset will not be of any value to the Lessor at the expiry of the lease term.

In the given case, lease period is 80% of the useful life of the asset and P V of MLP is 100%
Hence it should be classified as a Finance or capital lease
Date	Particulars	Note	Debit	Credit
01.01.2021	Gross Asset A/c Dr		206065
To Lease rent payable A/c			206065
( Being the asset leased is recognised)
31.12.2021	Lease rent payable A/c Dr		39697
	Finance Cost A/c	1	10303
	To Bank A/c			50000
	( Being the Finance cost is recognised and lease rent paid)
	Depreciation A/c Dr		51523
	To accumulated Depreciaton A.c			51523
	( Being depreciation charges on the leased asset)

	Note 1	Finance cost calculation for 4 years
	Date	Opening Balance	Interest @5%	Lease payment	Principal amount	Closing Balance
	31.12.2021	206065	10303.25	50000	39696.75	166368.3
	31.12.2022	166368.3	8318.413	50000	41681.59	124686.7
	31.12.2023	124686.7	6234.333	50000	43765.67	80921
	31.12.2024	80921	4046.05	50000	45953.95	34967.05	Guaranteed Residual value