Maher has entered into a lease agreement with Johanson Company on January 1, 201
ID: 2464651 • Letter: M
Question
Maher has entered into a lease agreement with Johanson Company on January 1, 2017.
1) The lease reverts back to Johanson Company at the end of the lease. Johanson does not offer a bargain purchase option.
2) The term of the lease is 6 years and requires annual payments of $12,000 at the end of the year.
3) The present value of the lease payments is $52,263 using an incremental rate of 10%, the equipment's fair value at lease inception is $62,500.
4) The equipment has an estimated life of 12 years.
Required:
1) Using the four classification criteria determine whether the lease qualifies as an operating or capital lease for Maher.
2.) Prepare the journal entries that Maher would make for 2017 and 2018.
Explanation / Answer
Answer
Answer 1
Using the four classification criteria determine whether the lease qualifies as an operating or capital lease for Maher.
Capital lease is a lease which transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee by the lessor but not the legal ownership.
In following situations, lease transactions are called capital lease.
The present value of the lease payments is $52,263.The equipment's fair value at lease inception is $62,500. So at beginning of lease period, the present value of lease payments cover substantially initial fair value i.e. 52263 / 62500 = 83.62 %.
So Lease is Qualified as Capital lease.
Answer 2
Figures in $
Year
Lease payment
Disc Rate : 10%
Present value
A
B
A*B
1
12000
0.909091
10909.09
2
12000
0.826446
9917.355
3
12000
0.751315
9015.778
4
12000
0.683013
8196.161
5
12000
0.620921
7451.056
6
12000
0.564474
6773.687
Present value
52263.13
Figures in $
Year
Opening liability
Instalment
Interest : 10%
Principal
Closing Balance
A
B
C
D
A*0.1
B-C
A-D
1
52263.13
12000
5226.31
6773.69
45489.44
2
45489.44
12000
4548.94
7451.06
38038.39
3
38038.39
12000
3803.84
8196.16
29842.22
4
29842.22
12000
2984.22
9015.78
20826.45
5
20826.45
12000
2082.64
9917.36
10909.09
6
10909.09
12000
1090.91
10909.09
0.00
Journal Entry
Year 2017
1. Capital Lease A/c Dr. $ 52263.13
To Johanson Company (Lessor) A/c Cr. $ 52263.13
2. Financial Charge A/c Dr. $ 5226.31
To Johanson Company (Lessor) A/c Cr. $ 5226.31
3. Johanson Company (Lessor) A/c Dr. $ 12000
To Bank A/c Cr. $ 12000
4. Depreciation A/c Dr. $ 8710.52 (52263.13 / 6 years)
To Capital Lease A/c Cr. $ 8710.52
Year 2018
1. Financial Charge A/c Dr. $ 4548.94
To Johanson Company (Lessor) A/c Cr. $ 4548.94
2. Johanson Company (Lessor) A/c Dr. $ 12000
To Bank A/c Cr. $ 12000
3. Depreciation A/c Dr. $ 8710.52 (52263.13 / 6 years)
To Capital Lease A/c Cr. $ 8710.52
Figures in $
Year
Lease payment
Disc Rate : 10%
Present value
A
B
A*B
1
12000
0.909091
10909.09
2
12000
0.826446
9917.355
3
12000
0.751315
9015.778
4
12000
0.683013
8196.161
5
12000
0.620921
7451.056
6
12000
0.564474
6773.687
Present value
52263.13
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