Question

Knight Company purchased a machine on January 1, 2015, for $625,000 for the express purpose of leasing it.  The machine was expected to have a nine-year life from January 1, 2015, to have no salvage value, and to be depreciated on the straight line basis.  On April 1, 2015, Knight leased the machine to McCracken Inc. for $150,000 a year for a four-year period ending March 31, 2019.  The appropriate interest rate is 12% compounded annually.  McCracken paid $150,000 to Knight on April 1, 2015.  Knight retains title to the property and plans to lease it to someone else after the four-year lease period.  Both Knight and McCracken use a calendar year basis for financial reporting purposes.

Record all entries for 2015 relating to the lease on the books of Knight.

Record all entries for 2015 relating to the lease on the books of McCracken.

Answer 1

First of all we have to know the types of Lease :

1. Finance Lease: A lease in which all risks and rewards are transferred to the owner of assets. The title may or may not eventually be transferred.

  Examples of Finance Lease are:

1. Lease in which Assets is transferred to lessee at the end of lease term

2. Lease term in which lessee has the option to purchase the assets form lessor at the price which is lower than fair price on the date when option become exercisable

3. Lease term Covers complete economic life of the asset even if title is not transferred

4. Lease term in which present value of the minimum lease payments is equal to or substantially covers the fair value of the leased asset.

2. Operating Lease: Any other lease other than finance lease is considered as an Operating Lease.

NOTE :

1. In the present case the Lease is Operating because Title is with Lessor(Knight) only.

2. Accounting in the books of Lessee in case of Operating Lease :

Lease payment is recognized as an expense in the profit and loss account.

3. Accounting in the books of Lessor in case of Operating Lease :

a. Lessor should record assets in balance sheet under fixed assets.

b. Lease income to recognize in statement of profit and loss account.

c. Cost incurred including depreciation to be recognized in statement of profit and loss account.

4. Calculation of Depreciation :

Depreciation = Asset Value - Salvage Value / Life of an Asset. => 625000-0/9 => $69445.

JOURNAL ENTRIES IN THE BOOKS OF KNIGHT COMPANY FOR THE YEAR 2015

S.NO DATE PARTICULARS    DEBIT($) CREDIT($)

01 Jan 1st 2015 Machine A/c Dr 625,000   

To Bank A/c 625,000

(Being Purchased new machine)

02 Apr 1st 2015 Bank A/c Dr 150,000

To McCracken Inc 150,000

(Being McCracken Paid Lease Rent)

03 Dec 31st 2015 McCracken A/c Dr 150,000

To Lease Rent of Machinery A/c 112500

To Lease rent received in Advance A/c   37500

(Being Lease amount calculated for only 9 months

i.e upto 31st Dec only)

04 Dec 31st 2015 Depreciation A/c Dr 69445

To Profit & Loss A/c Dr 69445

(Being Depreciation accounted for the year 2015)

JOURNAL ENTRIES IN THE BOOKS OF McCRACKEN INC FOR THE YEAR 2015

S.NO DATE PARTICULARS    DEBIT($) CREDIT($)   

  

01 Apr 1st 2015 Knight Company A/c Dr 150,000

To Bank A/c 150,000

(Being amount paid for Machine Lease)

02 Dec 31st 2015 Lease Rent of Machine A/c Dr 112,500

Lease Rent Paid in Advance A/c Dr 37,500

To Knight Company A/c 150,000

(Being Lease rent treated as expense)

03 Dec 31st 2015 Profit & Loss A/c Dr 112,500

To Lease Rent of Machine A/c 112,500