Exercise 21-1 On January 1, 2014, Burke Corporation signed a 7-year noncancelabl

Question

Exercise 21-1

On January 1, 2014, Burke Corporation signed a 7-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $9,444 at the beginning of each year, starting January 1, 2014. The machine has an estimated useful life of 8 years and a $4,570 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Burke uses the straight-line method of depreciation for all of its plant assets. Burke’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Prepare all necessary journal entries for Burke for this lease through January 1, 2015. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.)

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Date

Account Titles and Explanation

Debit

Credit

1/1/14

(To record the lease.)

(To record first payment.)

12/31/14

(To record depreciation.)

(To record interest.)

1/1/15

(To record second payament.)

$

Explanation / Answer

Bruke's lease term is 7 years which is more than 75% of the economic life of 8 years, so it is a capital lease.

Now, present value of minimum lease payments = annual payments X Present value of annuity due factor (11%, 7 years)

= $9,444 X 5.23 = $49,392

Journal entries

1/1/14 Lease equipment $49,392

Lease Liability $49,392   

(To record Lease)

Lease Liability $9,444

Cash $9,444

(To record First payment)

12/31/14 Depreciation expense ($49,392/7) $7,056

Accumulated Depreciation - Capital Lease $7,056

(To record Depreciation)

Interest Expense ($49,392 - $9444)11% $4,394

Interest payable $4,394

(To record Interest)

1/1/15 Lease Liability $5,050

Interest Payable $4,394

Cash $9,444

(To record Second payment)

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