Question

Part 3: Lessee Entries: Capital Lease On January 1, 2015, Southern, Inc. signed a 10-year non-cancelable lease for a machine. The terms of the lease called for Southern to make annual payments of $17,336 at the beginning of each year, starting January 1, 2015. The machine has an estimated useful life of 12 years. The machine reverts back to the lessor at the end of the lease term. Southern uses the straight-line method of depreciation for all of its plant assets. Southern’s incremental borrowing rate is 6%, and the Lessor’s implicit rate is unknown.

dentify and explain the type of lease. Use the blank area in the template following the journal entries to make your notes.

Compute the present value of the minimum lease payments.

Prepare all necessary journal entries for Southern for this lease through January 1, 2016.

Where appropriate, show all calculations leading to the final solution.

Answer 1

	Present value of minimum lease payament:
	Lease payment is at the beginning of the year for 10 years
	Year	Lease Payment	Discount Factor @ 6%	Discounted cashflow
	0	17336	1	17336
	1 to 9	17336	6.802	117919.47
				135255.47
	Present value of minimum lease payment=135255
	Journal entries:
	Date	Account titles and explantion			Debit	Credit
	2015
	Jan 1.	Equipment			135255
		Lease liability				135255
		(Purchase of machinery on lease)
	Jan 1.	Lease liability			17336
		Cash				17336
		(Lease rental paid)
	Dec 31.	Interest expense			7075
		Interest payable		(135255-17336)*6%		7075
		(Interest accrued)
	Dec 31.	Depreciation expense			13526
		Accumulated depreciation				13526
		(135255/10)
		(Depreciation expenses recorded)
	2016
	Jan 1.	Lease liability			10261
		Interest payable			7075
		Cash				17336
		(Lease rental paid)