Question

Pearl Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2020. Annual rental payments of $61,020 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%; Pearl’s incremental borrowing rate is 9%. Pearl is unaware of the rate being used by the lessor. At the end of the lease, Pearl 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. Pearl uses the straight-line method of depreciation on similar owned equipment.

Prepare the journal entries, that Pearl should record on December 31, 2020.

Prepare the journal entries, that Pearl should record on December 31, 2021.

Answer 1

Lease Liability = $61,020 X PVAD 9%, 5 = $61,020 x 4.23972 = $258,708
	Year	Lease PMT	Interest	Lease Reduction	Lease Liability
	0				$258,708
	1	$61,020	-	-	$197,688
	2	$61,020	$17,792	$43,228	$154,460
	3	$61,020	$13,901	$47,119	$107,341
	4	$61,020	$9,661	$51,359	$55,982
	5	$61,020	$5,038	$55,982	$0
Date	Accounts Titles and Explanation	Debit	Credit
12/31/20	Right-of-use Asset	$258,708
	Lease Liability		$258,708
	(To record lease)
12/31/20	Lease Liability	$61,020
	Cash		$61,020
	(To record lease payment)
12/31/21	Lease Liability	$43,228
	Interest Expense	$17,792
	Cash		$61,020
	(To record lease payment)
	Amortization Expense	$36,958		($258,708 / 7 years)
	Right-of-use Asset		$36,958
	(To record amortization)