Question

On January 1, 2017, the Millwork Company signed a four-year non-cancelable lease of equipment from the Midford Company. The annual lease payments of $35,000 are to be paid on January 1 of each year. The first payment is due on January 1, 2017. The lease contains a bargain purchase option price of $15,000. The equipment's fair value is expected to be $30,000 on December 31, 2020. The estimated economic life of the equipment is six years, and the estimated residual value at the end of six years is $5,000. The fair value of the equipment on January 1, 2017, is $140,000. Millwork's incremental borrowing rate is 12%, and the implicit interest rate used in the lease agreement is 10%, which is known by Millwork. The executory costs to be paid by Millwork at the end of 2017 are insurance, $1,200 and property taxes, $2,000.

Instructions:

1.) Examine and evaluate each capitalization criteria and determine the type of lease for Millwork.

2.) Calculate the amount of the asset and liability to be reported by Millwork at the inception of the lease (round to the nearest dollar). Hint: The Present Value of an Annuity table is used when the payment is at the end of the period and the Present Value of an Annuity Due table is used when the payment is made at the beginning of the period.

3.) Prepare the journal entries for Millwork for 2017

YOU MUST SHOW ALL SUPPORTING CALCULATIONS. *in U.S. dollar

Answer 1

1) It is an Capital Lease beacuse following transaction covered under following criteria:

a. The lease contain a bargain purchase option.

b. The PV of Minimum lease payment is more than 90% of the fair value of lease property of lessor.

2)Asset Liability represented at the inception

Lease Asset: $132285

Liability ( Obligation under capital lease): $132285.

3) Journal Entery

Journal Entry
Date	Account Tittle & Explanation	Debit	Credit
01/01/2017	Leased Equipment	$132,285.00
	Obligations under Capital Leases		$132,285.00
	To Record Leased Asset & liability
01/01/2017	Obligations under Capital Leases	$35,000.00
	Cash		$35,000.00
	To Record Lease rental Payment made
31/12/2017	Interest Expense	$35,000.00
	Interest Payable		$35,000.00
	To Record Lease Payment and Interest expense
31/12/2017	Amortization Expense on Leased Equipment	$33,071.25
	Accumulated Amortization of Leased Equipment		$33,071.25
	( $132285)/4
	To Record Amortisation Expense

Working Note

Computation of Present Value of Minimum Lease Payment
PV of Minimum Payment ($35000X3.48685)	$122,040
PV of Bargain Purchase Option ( $15000X 0.68301)	10245
PV of Minimum Lease Payment	$132,285

Lease Amortization Schedule
Date	Annual Lease Payment Plus BPO	Interest on Lability @10%	Reduction of Lease Liability	Lease Liability
01/01/2017				$132,285
01/01/2017	$35,000		$35,000	$97,285
31/12/2017		$9,728.50		$97,285