31. Lessee accounting- capital lease. Eubank Company, as lessee, enters into a l

Question

31. Lessee accounting- capital lease. Eubank Company, as lessee, enters into a lease agreement on July 1, 2018, for equipment. The following data are relevant to the lease agreement 1. The term of the noncancelable lease is 4 years, with no renewal option. Payments of $978,446 are due on July 1 of each year. 2. The fair value of the equipment on July 1, 2018 is $3,500,000. The equipment has an economic life of 6 years with no salvage value. 3. Eubank depreciates similar machinery it owns on the sum-of-the-years'-digits basis 4. The lessee pays all executory costs 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 (present value factor for 4 periods at 8%, 3.57710, at 10%, 348685). Instructions (a) Indicate the type of lease Eubank Company has entered into and what accounting T treatment is applicable. (b) Prepare the jounal 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 July 1, 2018. 2. December 31, 2018 3. July 1, 2019 4. December 31, 2019

Explanation / Answer

SOLUTION

(A) Capitalized amount:

$978,446 * PV of an ordinary annuity for 4 periods at 8%

= $978,446 * 3.57710 = $3,500,000

Because the present value of the lease payments ($3,500,000) equals the fair value,$3,500,000, of the leased property, it is a capital lease and must be accounted for under the capital lease method.

(B)

Lease Amortization Schedule-

Date Account titles adn Explanation Debit ($) Credit ($) July 1, 2018 Leased Equipment Under Capital Leases 3,500,000   Lease Liability 3,500,000 Dec.31, 2018 Depreciation Expense [($3,500,000 *4/10)* 6/12] 700,000   Accumulated Depreciation- Capital Leases 700,000 Interest Expense ($3,500,000*8%*6/12) 140,000 Interest Payable 140,000 July 1 ,2019 Interest Expense 280,000 Lease Liability 698,446 Cash 978,446 Dec.31,2019 Depreciation Expense 1,225,000 Accumulated Depreciation- Capital Leases 1,225,000 [($3,500,000 *4/10)* 6/12] + [($3,500,000 *3/10)* 6/12] Interest Expense (224,124 * 6/12) 112,062   Interest Payable 112,062

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