Question

1. Doris Smith recorded a capital lease at PV $350,640 on January 1, 2017. The interest rate is 11%. The leased asset has a life of 8 years. Smith made the first lease payment of $57,051 on 1/1/17.

The lease requires 6 annual payments.

1. Why is this a capital lease?
2. Prepare the amortization schedule for the first 3 years for the lessee lessor
3. Prepare lessee and lessor journal entries for the first three years
4. Assume, additionally, that there is an unguaranteed residual of $12,000, PV-$10,000. Prepare the amortization schedules and journal entries for the lessee and lessor for the first 2 years.

Answer 1

Answer :

(a).Why is this a capital lease?

As the life of lease covers a significant portion (75%) of the economic life of the asset, therefore, it has been classified as capital lease. (8 years *75% = 6 years)

(b). Amortization Schedule for first 3 years

Annual payment Involve as
Year	Opening Balance	Annual Payment	Interest Expenses	Principal Payment	Closing Balance
1	350640.00	57051.00	0.00	57051.00	293589.00
2	293589.00	57051.00	32294.79	24756.21	268832.79
3	268832.79	57051.00	29571.61	27479.39	241353.40
4	241353.40	57051.00	26548.87	30502.13	210851.27

Note: As the first payment has been made on January 1, 2017 that is date of lease agreement, hence the first lease payment does not involve any interest component, while the second lease payment on January 1, 2018 involves interest for on year on the balance outstanding in first year and so on.

(c). Journal Entries:

In the book of Lessor:

Jan 1, 2017	Leased Asset	350640
	To Cash		57051
	To Lease Liability		293589
Dec 31, 2017	Depreciation Expense (350640/8)	58440
	To Accumulated Depreciation		58440
Dec 31, 2017	Interest Expenses	32294.79
	To Interest Payable		32294.79
Jan 1, 2018	Interest Payable	32294.79
	Lease Liability	24756.21
	To cash		57051
Dec 31, 2018	Depreciation Expense (350640/6)	58440
	To Accumulated Depreciation		58440
Dec 31, 2018	Interest Expenses	29571.61
	To Interest Payable		29571.61
Jan 1, 2019	Interest Payable	29571.61
	Lease Liability	27479.39
	To cash		57051.00
Dec 31, 2019	Depreciation Expense (350640/8)	58440
	To Accumulated Depreciation		58440
Dec 31, 2019	Interest Expenses	26548.87
	To Interest Payable		26548.87

In the books of Lessee:

Jan 1, 2017	Cash	57051
	Lease Receivables	293589
	To Asset		350640
Dec 31, 2017	Interest Receivable	32294.79
	To Finance Income		32294.79
Jan 1, 2018	Cash	57051
	To Lease Receivables		24756.21
	To Interest Receivable		32294.79
Dec 31, 2018	Interest Receivable	29571.61
	To Finance Income		29571.61
Jan 1, 2019	Cash	57051.00
	To Lease Receivables		27479.39
	To Interest Receivable		29571.61
Dec 31, 2019	Interest Receivable	26548.87
	To Finance Income		26548.87