On December 31, 2014 Company X entered a lease agreement for the rental of machi

Question

On December 31, 2014 Company X entered a lease agreement for the rental of machinery under the following terms:
1- The lease is for 5 years and is non-cancelable
2- Payments are due at the beginning of the period and are paid annually
3- There is an option to extend the lease for 2 more years and it is reasonalbe certain that X will re-new the lease after 5 years
4- The lease payments are $7,000 per year
5- The estimated useful life of the machinery is 9 years
6- There are no bargain purchase options at the end of the lease term
7- The implicit rate on the lease is 4 percent and te incremental borrowing rate to X is 5 percent
8- The fair market value of the equipment on the inception date is $50,000.

Using the present lease rules-ASU 840, please answer the following : Keep in mind that X will prefer to treat thism lease as an off balance sheet transaction.

1- What type of lease is this to X? Why?
2- Record the journal entry on December 31, 2014
3- Prepare a Balance Sheet to reflect this lease transaction as of January 1, 2017
4- Prepare the income statement effects of this lease for the 2016 calendar year
5- Prepare the cash flow effects of this lease for the 2018 calendar year

Explanation / Answer

1. This is an Operating lease due to the following reasons:

2. Journal

3. There will be no effect of this transaction on balance sheet. Neither an asset nor liability will be created. Only that the Cash will be reduced and retained earnings will also get reduced due to this expense.

4. Income statement

5.

Date Account Name Debit Credit Dec 31, 2014 Lease rental expense $7000 Cash $7000 (To record payment of lease rental)

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