Question

. Eubank Company, as the lessee, enters into a lease agreement on January 1, 2020, for equipment. The following data are relevant to the lease agreement:

1.   The term of the noncancelable lease is 4 years. Payments of $978,446 are due on January 1 of each year.

2.   The fair value of the equipment on January 1, 2020 is $3,6000,000. The equipment has an economic life of 6 years with no salvage value.

3.   Eubank depreciates similar machinery it owns on the straight-line basis.

4.   The lessee pays all executory costs.

5.   Eubank’s incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 8% in computing the lease payments.

Instructions

(a)    Indicate the type of lease Eubank Company has entered into (show your computations for the “tests”) and what accounting treatment is applicable.

(b)    Prepare the journal entries on Eubank’s books that relate to the lease agreement for the following dates: (Round all amounts to the nearest dollar. Include a partial amortization schedule.)

        1.    January 1, 2020.

        2.    December 31, 2020.

        3.    January 1, 2021.

Answer 1

(a)	$978,446 × PV of an ordinary annuity for 4 periods at 8%
	$978,446 × 3.5771 = $3,500,000
	Because the present value of the lease payments ($3,500,000) are not equals
	the fair value, $3,600,000, of the leased property, it is a capital lease and
	must be accounted for under the capital lease method.
(b)	Date	Account Titles and Explanation	Debit	Credit
	Jan 1, 2020	Leased Equipment	$3,500,000
		Lease Liability		$3,500,000
		Lease Liability	$978,446
		Cash		$978,446
	Dec 31, 2020	Depreciation Expense	$875,000
		Accumulated Depreciation - Leased Equipment		$875,000
	Jan 1, 2021	Interest Expense	$201,724
		Lease Liability	$776,722
		Cash		$978,446