Question

ALL LEASES BELOW ARE BETWEEN LUNA AND JACK

A. On January 1, 2021, Jack leased office space from Luna under a 20-year operating lease agreement. Luna’s borrowing rate is 5%. The lease calls for annual lease payments of $10,000 on January 1 of each year. Record all journal entries related to the lease for 2021, 2022, and 2023 for both Luna and Jack.

B. On January 1, 2021, Jack leased a catnip processing factory for a 4-year period ending December 31, 2024, at which time possession of the machine will revert back to Luna. Jack intends to use the machine to make catnip-filled mice so that cats around him will chill out and he can nap peacefully in the afternoon. The machine cost Luna $450,000 and has an expected useful life of 5 years. Luna expects the residual value to be $55,000 at the end of the lease. Jack told Luna that he would try to assure that this residual value is met. Annual payments of $161,150.00 are due every January 1. Luna’s expected rate of return on the lease is 5%, which Jack does not know. Jack’s incremental borrowing rate is 8%. Luna and Jack use straight line depreciation. Prepare the amortization schedules and all journal entries for both Luna and Jack.

C. On January 1, 2021, Jack leased a warehouse from Luna. The lease specified annual payments of $15,000 beginning January 1, 2021, and each January 1 through 2024. Luna’s rate for determining payments was 12%. At the end of the lease, the warehouse was expected to be worth $5,000. The estimated life of the warehouse is 5 years with no salvage value used in depreciation calculations. Luna and Jack use straight-line depreciation. Jack guaranteed a residual value of $2,500. Jack’s incremental borrowing rate is 8%. A $800 per year cleaning agreement was arranged for the warehouse with an outside service firm. During contract negotiations, Luna agreed to pay this fee and included it in the $15,000 lease payment.

1. How should this lease be classified by Luna and by Jack and why?

2. Prepare the amortization schedule and all journal entries for Luna.

3. Prepare the amortization schedule and all journal entries for Jack.

Answer 1

solution :

1)	Under operating lease , risk and reward is born by lessor .
	Lesse should not capitalise the lease rentals .
	Lessor owns the asset and lessee rents the asset in return for a periodical payments as well.
	At the end of lease term lessee returns the asset to lessor .
2)	IN THE BOOKS OF LUNA
	DATE	Particuars	DEBIT	CREDIT
	01-Jan-21	Bank a/c	$10,000
		To unearned Rent Revenue a/c		$10,000
	31-Dec-21	To unearned Rent Revenue a/c	$10,000
		To Rent a/c		$10,000
	01-Jan-22	Bank a/c	$10,000
		To unearned Rent Revenue a/c		$10,000
	31-Dec-22	To unearned Rent Revenue a/c	$10,000
		To Rent a/c		$10,000
	01-Jan-23	Bank a/c	$10,000
		To unearned Rent Revenue a/c		$10,000
	31-Dec-23	To unearned Rent Revenue a/c	$10,000
		To Rent a/c		$10,000
3)	IN THE BOOKS OF JACK
	DATE	Particuars	DEBIT	CREDIT
	01-Jan-21	Rent expense a/c	$10,000
		To Bank a/c		$10,000
	01-Jan-22	Rent expense a/c	$10,000
		To Bank a/c		$10,000
	01-Jan-23	Rent expense a/c	$10,000
		To Bank a/c		$10,000