Question

**PLEASE SHOW AND EXPLAIN ALL PARTS***

Michael Scott Paper Company (MSPC) started their operations late in July 2018.  The owner (Michael Scott) assumed he could run the company from his apartment, however, due to covenants in his housing contract he was unable to run his business from home.  As a result, Michael decided to buy a warehouse.  After much deliberation and consideration, he determined that leasing a warehouse would be more financially viable than buying one.

Michael reached out to an old friend who helped him lease a warehouse from Darrel Inc.  The warehouse has a current value of $510,000.  The lease calls for MSPC to make 25 annual payments of $58,058.02 beginning January 1^st, 2019, which is the beginning of the lease, and at each January 1^st, thereafter.  The warehouse’s useful life is 50 years.  The going interest rate for warehouse rental in the area is 12%.  Assume that the annual amortization expense for the prior period is recorded at the same time as the annual lease payment.

1) Create an amortization schedule

2) What type of lease has MSPC entered? How did you determine this?

3)What journal entries will MSPC make on January 1^st, 2019?

4)What journal entries will MSPC make on January 1^st, 2026?

5)What journal entries will MSPC make on January 1^st, 2042?

Answer 1

1.  

Payment Term	Amount	PV Factor	DCF
Jan 1 2019	58,058.02	0.89	51,837.52
Jan 1 2020	58,058.02	0.80	46,283.50
Jan 1 2021	58,058.02	0.71	41,324.55
Jan 1 2022	58,058.02	0.64	36,896.92
Jan 1 2023	58,058.02	0.57	32,943.68
Jan 1 2024	58,058.02	0.51	29,414.00
Jan 1 2025	58,058.02	0.45	26,262.50
Jan 1 2026	58,058.02	0.40	23,448.66
Jan 1 2027	58,058.02	0.36	20,936.30
Jan 1 2028	58,058.02	0.32	18,693.13
Jan 1 2029	58,058.02	0.29	16,690.29
Jan 1 2030	58,058.02	0.26	14,902.05
Jan 1 2031	58,058.02	0.23	13,305.40
Jan 1 2032	58,058.02	0.20	11,879.82
Jan 1 2033	58,058.02	0.18	10,606.98
Jan 1 2034	58,058.02	0.16	9,470.52
Jan 1 2035	58,058.02	0.15	8,455.82
Jan 1 2036	58,058.02	0.13	7,549.84
Jan 1 2037	58,058.02	0.12	6,740.93
Jan 1 2038	58,058.02	0.10	6,018.69
Jan 1 2039	58,058.02	0.09	5,373.83
Jan 1 2040	58,058.02	0.08	4,798.06
Jan 1 2041	58,058.02	0.07	4,283.98
Jan 1 2042	58,058.02	0.07	3,824.98
Jan 1 2043	58,058.02	0.06	3,415.16
Total Payment	14,51,450.50	NPV	4,55,357.13

Lease Amortization Schedule

Payment Term	Payment	Principal	Interest	Balance
Opening Balance				4,55,357.13
Jan 1 2019	58,058.02	3,415.16	54642.86	4,51,941.96
Jan 1 2020	58,058.02	3,824.98	54233.04	4,48,116.98
Jan 1 2021	58,058.02	4,283.98	53774.04	4,43,833.00
Jan 1 2022	58,058.02	4,798.06	53259.96	4,39,034.94
Jan 1 2023	58,058.02	5,373.83	52684.19	4,33,661.11
Jan 1 2024	58,058.02	6,018.69	52039.33	4,27,642.42
Jan 1 2025	58,058.02	6,740.93	51317.09	4,20,901.49
Jan 1 2026	58,058.02	7,549.84	50508.18	4,13,351.65
Jan 1 2027	58,058.02	8,455.82	49602.2	4,04,895.83
Jan 1 2028	58,058.02	9,470.52	48587.5	3,95,425.31
Jan 1 2029	58,058.02	10,606.98	47451.04	3,84,818.32
Jan 1 2030	58,058.02	11,879.82	46178.2	3,72,938.50
Jan 1 2031	58,058.02	13,305.40	44752.62	3,59,633.10
Jan 1 2032	58,058.02	14,902.05	43155.97	3,44,731.05
Jan 1 2033	58,058.02	16,690.29	41367.73	3,28,040.76
Jan 1 2034	58,058.02	18,693.13	39364.89	3,09,347.63
Jan 1 2035	58,058.02	20,936.30	37121.72	2,88,411.33
Jan 1 2036	58,058.02	23,448.66	34609.36	2,64,962.67
Jan 1 2037	58,058.02	26,262.50	31795.52	2,38,700.17
Jan 1 2038	58,058.02	29,414.00	28644.02	2,09,286.17
Jan 1 2039	58,058.02	32,943.68	25114.34	1,76,342.49
Jan 1 2040	58,058.02	36,896.92	21161.1	1,39,445.57
Jan 1 2041	58,058.02	41,324.55	16733.47	98,121.02
Jan 1 2042	58,058.02	46,283.50	11774.52	51,837.52
Jan 1 2043	58,058.02	51,837.52	6220.502	0.00

2.

The lease is a operating lease, since the lease does not offer a purchase option at the end of the lease period or lease period exceeds 75% of the economic life of the asset or the PV of lease payment exceeds 90% ($510000 x 90% = $459000 , Pv is only $455357.13) of the asset fair value.

3 , 4 & 5.

Since it is an operating lease, the payments will be accounted as an expense in the books of the lessee. Thus the entry will be

Lease Expenses A/c Dr. 58058.02

To Bank A/c 58058.02