Question

# Grouper Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December...

Grouper Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2020. Annual rental payments of \$56,000 are to be made at the beginning of each lease year (December 31). The interest rate used by the lessor in setting the payment schedule is 6%; Grouper’s incremental borrowing rate is 8%. Grouper is unaware of the rate being used by the lessor. At the end of the lease, Grouper has the option to buy the equipment for \$5,000, considerably below its estimated fair value at that time. The equipment has an estimated useful life of 7 years, with no salvage value. Grouper uses the straight-line method of depreciation on similar owned equipment.

A. Prepare the journal entries, that Grouper should record on December 31, 2020. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answers to 0 decimal places, e.g. 58,971.)

 Date Account Titles and Explanation Debit Credit December 31, 2020 (To record leased asset and related liability.) (To record the first rental payment.)

Solution:

Lease liability = Present value of lease payment + Present value of bargain purchase option

= \$56,000 * Cumulative PV Factor at 8% for 5 periods of annuity due + \$5,000 * PV factor at 8% for 5th period

= \$56,000 * 4.31213 + \$5,000 * 0.68058

= \$244,882

 Grouper Steel Company Journal Entries Date Particulars Debit Credit 31-Dec-20 Equipment Dr \$244,882.00 To Lease Payable \$244,882.00 (To record lease liability) 31-Dec-20 Lease payable Dr \$56,000.00 To Cash \$56,000.00 (To record lease payment)

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