Question #2: On January 1, 2014, Hayes, Inc. leases equipment from Smithsonian C
ID: 2596379 • Letter: Q
Question
Question #2: On January 1, 2014, Hayes, Inc. leases equipment from Smithsonian Company for an annual lease rental of $25,000. The lease term is five years, and the lessor's interest rate implicit in the lease is 8%. The lessee's incremental borrowing rate is 8.25%. The useful life of the equipment is five years, and its estimated residual value equals its removal cost. Annuity tables indicate that the present value of an annual lease rental of $1 (at 8% rate) is $3.993. The fair value of leased equipment equals the present value of rentals. (Assume the lease is capitalized.) Required: Prepare accounting entries required by Hayes, Inc. for 2014. Compute and illustrate the effect on the income statement for the year ended December 31, 2014, and for the balance sheet as of December 31, 2014. Construct a table showing payments of interest and principal made every year for the five-year lease term. Construct a table showing expenses charged to the income statement for the five-year lease term if the equipment is purchased. Show a column for (1) amortization, (2) interest, and (3) total expenses. In one paragraph, discuss the income and cash flow implications from this capital lease.
Explanation / Answer
Present value of Lease rentals $ 99,825 (3.993*25000) ACCOUNTING ENTRIES REQUIRED FOR 2014 Date Account Title Debit Credit Jan1, 2014 Leased asset $ 99,825 Lease liability $99,825 Dec.31, 2014 Lease liability $17,014 Interest expense $7,986 (99825*0.08)= 7,986 Cash $25,000 Dec.31, 2014 Depreciation $19,965 (99825/5)= 19,965.00 Accumulated depreciation $19,965 CALCULATION OF INTEREST RATE FOR EACH OF FIVE YEARS Beginning liability interest payment Ending Liability year1 $ 99,825 7986 -25000 82811 year2 82811 6624.88 -25000 64435.88 year3 64435.88 5154.8704 -25000 44590.7504 year4 44590.7504 3567.26 -25000 23158.0104 year5 23158.01043 1852.6408 -25000 10.6512666 Effect on the Income Statement: Interest and depreciation expenses will reduce the income Effect on the Balance sheet: Asset and liability will increase and cash will decrease AMORTIZATION TABLE {1} {2} {3} Year Amortization Interest Total expense 1 $ 17,014.00 $ 7,986.00 $ 25,000 2 $ 18,375.12 $ 6,624.88 $ 25,000 3 $ 19,845.13 $ 5,154.87 $ 25,000 4 $ 21,432.74 $ 3,567.26 $ 25,000 5 $ 23,147.36 $ 1,852.64 $ 25,000 TOTAL $ 99,814.35 The difference of $10.65 is due to approximation in the PV factor of$3.993 to three decimal places