*Problem 21A-3 a-d Kingbird Steel Company, as lessee, signed a lease agreement f
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Question
*Problem 21A-3 a-d
Kingbird Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of $61,020 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 7%; Kingbird’s incremental borrowing rate is 9%. Kingbird is unaware of the rate being used by the lessor. At the end of the lease, Kingbird 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. Kingbird uses the straight-line method of depreciation on similar owned equipment.
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Date
Account Titles and Explanation
Debit
Credit
December 31, 2017
(To record leased asset and related liability.)
(To record the first rental payment.)
Date
Account Titles and Explanation
Debit
Credit
December 31, 2018
(To record amortization.)
(To record annual payment on lease liability.)
Date
Account Titles and Explanation
Debit
Credit
December 31, 2019
(To record annual amortization on leased assets.)
(To record annual payment on lease liability.)
Assets
Liabilities
Kingbird Steel Company, as lessee, signed a lease agreement for equipment for 5 years, beginning December 31, 2017. Annual rental payments of $61,020 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 7%; Kingbird’s incremental borrowing rate is 9%. Kingbird is unaware of the rate being used by the lessor. At the end of the lease, Kingbird 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. Kingbird uses the straight-line method of depreciation on similar owned equipment.
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Explanation / Answer
Since the lessors's interest rate is unknown to the lessee, the lessee's incremental borrowing rate of 9% will be used for the computations.
Since there is a bargain purchase option at the end of the lease term , one of the conditions of a capital lease is fulfilled. Therefore, it will be treated as a capital lease.
Present value of the minimum lease payments = Annual lease payments x PVAD 9%, n=5
= $ 61,020 x 4.23972 = $ 258,707.71 or $ 258,708.
In the books of Kingbird Steel Company:
Date Account Titles Debit Credit $ $ December 31 2017 Leased Asset 258,708 Lease Liability 258,708 December 31, 2017 Lease Liability 61,020 Cash 61,020 December 31, 2018 Depreciation Expense ( $ 258,708 / 5) 51,742 Accumulated Depreciation : Leased Asset 51,742 December 31, 2018 Lease Liability 43,228 Interest Expense ( $ 258,708 - 61,020) x 9% 17,792 Cash 61,020 December 31, 2019 Depreciation Expense 51,742 Accumulated Depreciation: Leased Asset 51,742 December 31, 2019 Lease Liability 47,119 Interest Expemse 13,901 Cash 61,020Related Questions
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