Question

On January 2, 201X, Tools, Inc. entered into a 6 year, non cancelable lease for a fleet trucks. The economic life of the trucks are 6 years, and title transfers at the end of the leasing period, with bargain purchase price of $50,000. The lease calls annual payments of $100,000, beginning with the signing of the lease, and at the beginning of the next five years. The bargain purchase price will be paid at the end of the 6th year. The borowing rate for Tools Inc is 6%. Required: 1) Calculate the NPV of the lease 2) Prepare "Schedule of Lese Payments" and show the totals of the lease payments, the interest expense and the principal payments 3) Prepare the first two years of journal entries related to the lease acquisition, payments, and amortization (straight-line) 4) Prepare the final journal entry at the end of 6th year for the purchase of the assets

Answer 1

1) The total NPV of lease will be equal to sum of present Value of annual lease payments and present value of bargain purchase option.

NPV of Lease = PV of Annual Lease Payments+PV of bargain purchase option

= [Annual lease Payments*PVAF(6, 6%)(beginning of year)]+[Purchase price*PVF(6 yrs, 6%)]

= ($100,000*5.212364)+($50,000*0.70496)

= $521,236+$35,248 = $556,484

2) Schedule of Lease Payments (Amounts in $)

Year (End)	Lease Payable balance (A)	Lease Payments (B)	Interest Expense (C = A*6%)	Decrease in Lease Payable (D = B - C)	Closing Lease Payable (A-D)
0	556,484	100,000	0	100,000	456,484
1	456,484	100,000	27,389	72,611	383,873
2	383,873	100,000	23,032	76,968	306,905
3	306,905	100,000	18,414	81,586	225,319
4	225,319	100,000	13,520	86,480	138,839
5	138,839	100,000	8,331	91,669	47,170
Total		600,000	90,686	509,314

3) Journal Entries (Amounts in $)

Date	Account Titles and Explanations	Debit	Credit
01/02/201X	Right of Use Asset	556,484
	Lease Payable		556,484
	(To record the lease liability)
01/02/201X	Lease Payable	100,000
	Cash		100,000
	(To record the first lease payment)
12/31/201X	Interest Expense [($556,484-$100,000)*6%]	27,389
	Interest Payable		27,389
	(To record the interest expense)
12/31/201X	Depreciation Expense ($556,484/6 yrs)	92,747
	Right of Use Asset		92,747
	(To record depreciation expense)
01/01/202X	Interest Payable	27,389
	Lease Payable	72,611
	Cash		100,000
	(To record the second lease payment)
12/31/202X	Interest Expense	23,032
	Interest Payable		23,032
	(To record the interest expense)
12/31/202X	Depreciation Expense ($556,484/6 yrs)	92,747
	Right of Use Asset		92,747
	(To record the depreciation expense)

4) Journal Entry (Amounts in $)

Account Titles and Explanations	Debit	Credit
Lease Payable	47,170
Interest Expense ($47,170*6%)	2,830
Cash		50,000