Question

1. Trevor Corporation entered into a lease agreement on January 1, 2016, to provide Jensen Company with an equipment. The terms of the lease agreement were as follows.

1. The lease is to be for 3 years with rental payments of $19,234 to be made at the beginning of each year.
2. The machinery has a fair value of $55,000, a cost of $40,000, and an economic life of 8 years.
3. At the end of the lease term, both parties expect the machinery to have no residual value.
4. The lease does not transfer ownership at the end of the lease term, does not have a bargain purchase option, and the asset is not of a specialized nature.
5. The implicit rate of Trevor is 5%, which is known to Jensen.
6. Collectibility of the payments is probable.

Instructions

(a) Show how the lease payment is derived by the lessor and discuss the nature of this    lease for the lessee (Jensen) and lessor (Trevor)

(b) Prepare the lease related journal entries for Jensen (the lessee) for 2016, 2017 and 2018. Jensen uses the straight method to depreciate the equipment over its lease term.

Answer 1

(a)	Lease payment	19,234	( 55,000 / 2.85941 )
	The nature of lease is Capital lease for the Lessee & Lessor, because the present value of lease payments of $ 55,000 is equal to fair value of machine of $ 55,000 .
(b)	Journal entries for Jensen (the lessee)
	Date	Particulars	Debit	Credit
	January 1,2016	Right of use asset	55,000
		Lease Liability		55,000
	January 1,2016	Lease Liability	19,234
		Cash		19,234
	December 31,2016	Amotization Expense	18,333
		Right of use asset		18,333
		(55,000 / 3 )
	December 31,2016	Interest Expense	1,788
		Interest Payable		1,788
		( 55,000 - 19,234 ) x 5%
	January 1,2017	Lease Liability	17,446
		Interest Payable	1,788
		Cash		19,234
	December 31,2017	Amotization Expense	18,333
		Right of use asset		18,333
		(55,000 / 3 )
	December 31,2017	Interest Expense	916
		Interest Payable		916
		( 55,000 - 19,234 - 17,446 ) x 5%
	January 1,2018	Lease Liability	18,318
		Interest Payable	916
		Cash		19,234
	December 31,2018	Amotization Expense	18,334
		Right of use asset		18,334
		(55,000 - 18,333 -18,333 )