Ayayai Corporation leased equipment to Kingbird, Inc. on January 1, 2017. The le

Question

Ayayai Corporation leased equipment to Kingbird, Inc. on January 1, 2017. The lease agreement called for annual rental payments of $1,451 at the beginning of each year of the 2-year lease. The equipment has an economic useful life of 6 years, a fair value of $7,100, a book value of $5,100, and Ayayai expects a residual value of $4,600 at the end of the lease term. Ayayai set the lease payments with the intent of earning a 4% return, though Kingbird is unaware of the rate implicit in the lease and has an incremental borrowing rate of 6%. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

1. What is the amount of the rental payments used in the lease agreement? 

2. Prepare the entries for Ayayai for 2017.

3. How would Ayayai’s accounting in part (a) change if it incurred legal fees of $500 to execute the lease documents and $300 in advertising expenses for the year in connection with the lease? 

Explanation / Answer

1. Amount of Rental Payments = 1451*2= $2902

2. Journal Entries in the books of Ayayai

a) Bank A/C Dr $ 1451

To Rental Income of Lease $ 1451

b) Depreciation A/C Dr $ 250

To Equipment A/C $ 250

3.

a) Legal Expenses A/C Dr $ 500

To Kingbird Inc $ 500

b) Profit & Loss A/C Dr. $ 300

To Advertisement Expenses A/C $ 300

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