Question

2016 to rent Horitzon Winery the equipment that Horitzon requires to expand its production capacity to meet? customers' demands for its products. The lease agreement calls for five annual lease payments of $ 110 000 at the end of each year. Horitzon has identified this as a finance lease.? Furthermore, the company has determined that the present value of the lease? payments, discounted at 12 %?, is $ 396 525. The leased equipment has an estimated useful life of five years and no residual value. Horitzon uses the? straight-line method for depreciating similar equipment that it owns.

Requirements a. Prepare a lease amortization schedule for this lease. b. Prepare the necessary journal entries for the first year of the lease. c. Use the student to show work button to answer the following questions. Justify the journal entry to raise the lease. Justify the calculation of depreciation.

Answer 1

Justification of depreciation and recording the lease

1. The lease is a financial lease as we know that RISK AND REWARDS OF OWNERSHIP transfer to LESSEE in this type of lease. So as per GAAPS we see substance over form principle is applicable here. The CONTROL OF ASSETS is totally in hands of lessee. Although the assets acquired on lease but because the control of asset is possessed by lessee ( transfer of risks and rewards of ownership means transfer of control of assets) . So we have to record both asset ( As ownership acquired) and lease liabilities ( present value of obligations - we record liabilities when outflow of financial resources is certain) Thus it is justified that lease should be recorded at inception.

Depreciation will be recorded by lessee as risk and rewards of ownership transferred to lessee. The depreciation is actually the reallocation of assets cost over the life of assets. It’s matching concept of accounting. As we record income for the year which is earned by using the assets of business we have to record the cost incurred for earning this income.As the lessee is using the equipment for generating the income, he will record depreciation as well. If you think that assets is also used by lessee in an operating lease but control of asset is not in hands of lessee in that type of lease. We record lease rents there.

Depreciation for each year as per straight line method

(Cost of assets- salvage value ) / Useful life of assets

Here (396525 - 0) / 5 = $ 79305.