Question

Question No. 1 Leases

Eagle River Inc. entered into a direct financing lease with Adolphe Leasing Company for equipment that has a fair value of $500,000. The term of the lease is 5 years and the useful life of the equipment is 8 years. The initial lease payment begins on March 1, 2020, with annual lease payments of $113,000 payable at the beginning of each lease year. Eagle River’s incremental borrowing rate is 7%. Adolphe’s pre-tax interest rate in the lease is 8%, but Eagle River is not aware of this rate. Eagle River amortizes equipment on a straight-line basis. Both companies have a December 31 fiscal year-end.

Required:

Prepare the journal entries for 2020 for the lessor and the lessee related to the direct financing lease.

Answer 1

IN THE BOOKS OF LESSEE

DATE	PARTICULARS	L/F	DEBIT($)	CREDIT($)
March 1	Lease receivable       To Unearned interest revenue       To Machine		565000	65000 500000
March 1	Cash       To Lease receivables		113000	113000
March 1	Unearned interest revenue (65000*7%)       To interest revenue		4550	4550
Dec 31	Depreciation       To Depreciation expense		66667	66667