Question

On January 2, Year 4, Drake Co. leased equipment from Brewer, Inc. Lease payments are $100,000, payable annually every December 31 for 20 years. Title to the equipment passes to Drake at the end of the lease term. The lease is noncancelable.

Additional Facts:

The equipment has a $750,000 carrying amount on Brewer’s books. Its estimated economic life was 25 years on January 2, Year 4.

The rate implicit in the lease, which is known to Drake, is 10%.

Drake’s incremental borrowing rate is 12%.

Drake normally uses the straight-line method of depreciation for equipment.

The rounded present value factors of an ordinary annuity for 20 years are as follows:

          12%     7.5
          10%     8.5

To prepare each required journal entry:

Enter the corresponding debit or credit amount in the associated column.

Round all amounts to the nearest whole number.

Not all rows in the table might be needed to complete each journal entry.

If no journal entry is needed, check the “No entry required” box at the top of the table as your response.

1 Record the journal entries for the following accounts for January 2, Year 4, if any.

Account Name	Debit	Credit
Leased equipment
Capital lease liability

2. Record the journal entries for the following accounts for December 31, Year 4, if any.

A)Capital lease liability

Cash

b)Depreciation expense

     Accumulated depreciation

C)

Interest expense
Capital lease liability

Answer 1

Solution 1:

As title of the equipment will be transferred to Drake at the end of lease term, therefore lease will be classified as capital lease.

As implicit rate of return of 10% of lessor is known to lessee therefore 10% rate will be used in computation of present value of lease payment.

Fair value of leased asset = Present value of lease payments = $100,000 * 8.50 = $850,000

Solution 2:

Journal Entries - Drake Co
Date	Particulars	Debit	Credit
Dec 31, Year 4	Interest Expense Dr ($850,000*10%)	$85,000.00
	Capital lease liability Dr	$15,000.00
	To Cash		$100,000.00
	(To record annual lease payment)
Dec 31, Year 4	Depreciation expense Dr ($850,000/25)	$34,000.00
	To Accumulated depreciation - Leased Equipment		$34,000.00