Exercise 21-1 On January 1, 2014, Burke Corporation signed a 7-year noncancelabl

Question

Exercise 21-1

On January 1, 2014, Burke Corporation signed a 7-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $9,195 at the beginning of each year, starting January 1, 2014. The machine has an estimated useful life of 8 years and a $5,490 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.

Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.)

Prepare all necessary journal entries for Burke for this lease through January 1, 2015. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places e.g. 58,971.)

Date

Account Titles and Explanation

Debit

Credit

1/1/14

(To record the lease.)

(To record first payment.)

12/31/14

(To record depreciation.)

(To record interest.)

1/1/15

(To record second payament.)

The present value of the minimum lease payments

$

Explanation / Answer

First lease payment on jan 1, 2014 i.e. in 0 period. The second payment in 1 period and so on. Therefore, the Cumulative PVF @ 10% for 7 periods starting with period 0 = 1+ 4.35526

= 5.35526

Present Value of Minimum Lease Payments = (9195 x 5.35526) + (5490 x 0.46651)

= $51803

Journal Entries:

Date Account Name Debit Credit 1/1/14 Equipment 51803        Lessor 51803 1/1/14 Lessor 9195         Cash 9195         12/31/14 Depreciation on Equipment 5790          Equipment 5790 12/31/14 Finance Charges [51803-9195] x 0.1 4261           Finance charges Payable 4261 1/1/15 Lessor 4934 Finance charges Payable 4261           Cash 9195

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