On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agree
ID: 2517616 • 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 550000
Cr. Cash 120,987
Cr. Lease liability 429013
b) Amortization of the leased asset
Dr. Depreciation 110,000
Cr. Accumulated depreciation 110,000
Interest expense
Dr. Interest expense 21,451
Cr. Lease liability 21,451
Amortization schedule
c)
Dr. Lease liability 104,513
Dr. Interest expense 11,674
Cr. Cash 120,987
d) Lease liability of 450,464
Balnce sheet:
Fixed Assets: 440,000
Lease liability: 450,464
e) No impact on liability. It shall be recorded as
Dr. Insurance expese
Cr. Cash
Years Opening balance Lease payment Interest expense Closing balance 1 550,000 (120,987) 21,451 450,464 2 450,464 (120,987) 16,474 345,950 3 345,950 (120,987) 11,248 236,212 4 236,212 (120,987) 5,761 120,986 5 120,986 (120,987) (0) (1)