On January 1, 2014, Buzzmore Company signed an agreement to lease equipment from

Question

On January 1, 2014, Buzzmore Company signed an agreement to lease equipment from Gavin Company. The term of the noncancelable lease is 5 years and requires annual lease payments of $7,195 on January 1, 2014, 2015, 2016, 2017 and 2018. Title to the equipment will pass to Buzzmore at the end of the lease term. The equipment has a value of $30,000 on January 1, 2014 and has an estimated life of 5 years with no salvage value. Buzzmore uses straight-line depreciation for its equipment and has an increment borrowing rate of 10%.

Buzzmore recorded the lease as an operating lease and made the following entry on January 1, 2014.

.

Debit: Rent Expense $7,195

Credit: Cash $7,195

.

As part of the audit team that is conducting the 2014 audit of Buzzmore’s financial statements, a member of the audit team believes the lease should be recorded as a capital lease. Do you agree? If you agree, prepare the correcting entry (or entries) that should be made as of December 31, 2014 to correct Buzzmore’s accounts assuming the company’s closing entries have not been made.

Explanation / Answer

Lease Payments Date Payments PV factor @10% PV of Cash flows Jan 1. 2014               7,195               1.000           7,195 Jan 1. 2015               7,195               0.909           6,541 Jan 1. 2016               7,195               0.826           5,946 Jan 1. 2017               7,195               0.751           5,406 Jan 1. 2018               7,195               0.683           4,914         30,002 So the PV of rental is approx              30,000 The title passes to Lessee after lease period, the PV of rentals is   equal to FV of Asset, and the life of lease is = Asset Life So The Lease needs to be traeted as Capital Lease. The rental will be treated as reapyment of Liability Total Liability              30,000 Less Advance payment                 7,195 Remaining Liability            22,805 Interest for the year @10%               2,281 Asset life 5 years SL depreciation per year               6,000 So Adjustoment Entries will Be : Account Title Dr $ Cr $ Asset A/C -Equipment            30,000 Lease Liability            30,000 (recording lease liability) Depreciation Expense-Equipment               6,000 Accumulated Depreciation               6,000 (recording depreciation) Interest Expense               7,195 Lease Liability               7,195 (first yr rental settled against lease liability) Interest Expense               2,281 Accrued Interest Payable               2,281 ( Accrual of Interest on the liability outstanding)

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.