On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agree
ID: 2517621 • Letter: O
Question
On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of $120,987 at the beginning of each year, starting January 1, 2017. The leased equipment is to be capitalized at $550,000. The asset is to be amortized on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 6%, and the implicit rate in the lease is 5%, which is known by Cage. Title to the equipment transfers to Cage at the end of the lease. The asset has an estimated useful life of 5 years and no residual value.
Instructions:
(a) Prepare the journal entry or entries that Cage should record on January 1, 2017.
(b) Prepare the journal entries to record amortization of the leased asset and interest expense for the year 2017. Include an amortization schedule.
(c) Prepare the journal entry to record the lease payment of January 1, 2018, assuming reversing entries are not made.
(d) What amounts will appear on the lessee’s December 31, 2017 balance sheet relative to the lease contract? Prepare a partial balance sheet showing the amounts.
(e) How would the value of the lease liability in part (b) change if Cage also agreed to pay the fixed annual insurance on the equipment of $2,000 at the same time as the rental payments?
Explanation / Answer
A. DR. Fixed Assets a/c $550000
CR. Cash a/c $120987
CR. Lease Liability a/c $429013
(Being asset taken on lease and initial payment done and liability recorded)
Depreciation schedule:-
Year Book value at the beginning Depreciation Closing book value
1 550000 220000((550000*40%) 330000
2 330000 132000((330000) 198000
3 198000 79200 118800
4 118800 59400* 59400
5 59400 59400 0
NOTE:- As the depreciation is higher in the 4th and 5th year so it is better to adopt straight line method.
B. DR. Depreciation a/c $220000
CR. Accumulated Depreciation a/c $220000
(Being depreciation accumulated)
DR. Depreciation a/c $132000
CR. Accumulated Depreciation a/c $132000
(Being depreciation accumulated)
DR. Depreciation a/c $79200
CR. Accumulated Depreciation a/c $79200
DR. Depreciation a/c $59400
CR. Accumulated Depreciation a/c $59400
DR. Depreciation a/c $59400
CR. Accumulated Depreciation a/c $59400
Calculation of interest and principal amount:-
Opening Interest 6% Payment Closing
Year 0 550000 ------- -120987 429013
Year 1 429013 21451 -120987 329477
Year 2 329477 16474 -120987 224964
Year 3 224964 11248 -120987 115225
Year 4 115225 5762 -120987 0
DR. Profit & Loss a/c $21451
CR. Interest a/c $21451
(Being interest expense recognised)
DR. Lease liability a/c $99536
DR. Interest a/c $21451
CR. Cash a/c $120987
DR. Lease liability a/c $104513
DR. Interest a/c $16474
CR. Cash a/c $120987
DR. Lease liability a/c $109739
DR. Interest a/c $11248
CR. Cash a/c $120987
DR. Lease liability a/c $115226
DR. Interest a/c $5761
CR. Cash a/c $120987
C.DR. Lease liability a/c $99536
DR. Interest a/c $21451
CR. Cash a/c $120987
(Being lease payment on January 1,2018)
D. Balance sheet as on 31st Dec,2017
LIABILITIES:-
Financial lease $330000
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