Question

(b) The information below relates to a leasing arrangement between Simmonds Leasing Company and Telsan Company, a lessee.

Inception date        January 1, 2020

Lease term         6 years

Annual lease payment due at the beginning of

each year, beginning with January 1, 2020   $150,000

Fair value of asset at January 1, 2020     $760,000

Economic life of leased equipment     7 years

Residual value of equipment at end of lease term,

guaranteed by the lessee       $65,500

Lessor’s implicit rate      10%

Lessee’s incremental borrowing rate    12%

January 1, 2020

The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $65,500. The lessee uses the straight-line depreciation method for all equipment.

Instructions

iii) Record the first year’s depreciation on Telsan Company’s books.

iv)Record interest expense and lease liability for Telsan Company for the year ending December 31, 2020.

Answer 1

Requirement 3: Record the following journal entry for depreciation expense

Date	Account Tilte and Explanation	Debit	Credit
Dec 31	Amortization Expense ($718,618.50 ÷ 6)	$119,769.75
2020	Right-of-Use Asset		$119,769.75
	To record depreciation

Requirement 4: Record the following journal entry for depreciation expense

Date	Account Tilte and Explanation	Debit	Credit
Dec 31	Interest Expense ($718,618.50 − $150,000) × 10%	$56,861.85
2020	Interest Payable		$56,861.85
	To record interest expense

Notes:

The lease is finance lease as meets the following two tests.

The lease term of the lease is 86% (6 years ÷ 7 years) and therefore meets lease term criteria.

The present value of the lease payment is $755,591 which is 95% of the fair value of leased asset and meets the present value test    

Present value of payments ($150,000 × $4.79079 (PVF-AD 6,10%))           = $718,618.50

Present value of the residual value ($65,500 × 0.56447 (PVF 6,10%))          = $36,972.79

Total present value                                                                                             $755,591.29