E21-1 (Lessee Entries; Capital Lease with Unguaranteed Residual Value) On Januar

Question

E21-1 (Lessee Entries; Capital Lease with Unguaranteed Residual Value) On January 1, 2014, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $8,668 at the beginning of each year, starting January 1, 2014. The machine has an estimated useful life of 6 years and a $5,000 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 10%, and the Lessor's implicit rate is unknown. Instructions (a) What type of lease is this? Explain b) Compute the present value of the minimum lease payments. (c) Prepare all necessary journal entries for Burke for this lease through January 1, 2015.

Explanation / Answer

a). This is a Capital Lease to Burke since the lease term (5 years) is greater than 75% of the economic life (6 years)

of the leased asset. the lease term is 5 / 6 = 83.33% of the asset's economic life.

b). Present Value of Minimum Lease Payments :-

= $8668 * 4.16986

= $36144

Present Value of an annuity for 5 years at 10% = 4.16986

c). Journal Entries :-

Date Particulars Debit ($) Credit ($) Jan. 1, 2014 Leased Equipment A/c Dr. 36144 To Lease Liability 36144 Jan. 1, 2014 Lease Liability A/c Dr. 8668 To Cash 8668 Dec. 31, 2014 Depreciation Expense A/c Dr. 7229 To Accumulated Depreciation 7229 ( Dep. on Capital Leases = $36144 / 5) Dec. 31, 2014 Interest Expense A/c Dr. 2748 To Interest Payable (($36144 - $8668)*10%) 2748 Jan. 1, 2015 Lease Liability A/c Dr. 5920 Interest Payable A/c Dr. 2748 To Cash 8668

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