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E21A­1. (Lessee Entries; Finance Lease with No Residual Value) (LO 1, 4) DU Journeys enters into an agreement with Traveler Inc. to lease a car on December 31, 2016. The following information relates to this agreement. 1.The term of the non­cancelable lease is 3 years with no renewal or bargain purchase option. The remaining economic life of the car is 3 years, and it is expected to have no residual value at the end of the lease term. 2.The fair value of the car was $15,000 at commencement of the lease. 3.Annual payments are required to be made on December 31 at the end of each year of the lease, beginning December 31, 2017. The first payment is to be of an amount of $5,552.82, with each payment increasing by a constant rate of 5% from the previous payment (i.e., the second payment will be $5,830.46 and the third and final payment will be $6,121.98). 4.DU Journeys' incremental borrowing rate is 8%. The rate implicit in the lease is unknown. 5.DU Journeys uses straight­line depreciation for all similar cars. Instructions (a) Prepare DU Journeys' journal entries for 2016, 2017, and 2018. (b) Assume, instead of a constant rate of increase, the annual lease payments will increase according to the Consumer Price Index (CPI). At its current level, the CPI stipulates that the first rental payment should be $5,820. What would be the impact on the journal entries made by DU Journeys at commencement of the lease, as well as for subsequent years?

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Answer:

(a) Prepare DU Journeys' journal entries for 2016, 2017, and 2018.

Date            Account Title and Explanation    Debit($)     Credit($)

31/12/2016  Right of Use asset                          15,000

                   Lease Liability                                                    15,000

(to record lease of asset)

31/12/2017  Interest Expense                             1,200

                  Lease Liability                                 4,352.82

                  Cash                                                                    5,552.82

(to record interest expense and lease payment)

31/12/2017  Amortization Expense                     5,000

                  Right of use Asset                                               5,000

(to record amortization expense for right of use asset)

31/12/2018 Interest Expense                               851.77

                 Lease Liability                                   4,978.69

                 Cash                                                                      5,830.46

(to record interest expense and lease payment)

31/12/2018 Amortization Expense                      5,000

                 Right of use Asset                                                 5,000

(to record amortization expense for right of use asset)

Date: 31/12/2016

Annual Payment: -

Interest Expense: -

Reduction of Lease Liability: -

Lease Liability: $15,000

Depreciation Expense: -

Date: 31/12/2017

Annual Payment: $5,552.82

Interest Expense: $1,200

Reduction of Lease Liability: 4352.82

Lease Liability: 10647.18

Depreciation Expense: $5,000

Date: 31/12/2018

Annual Payment: $5,830.46

Interest Expense: 851.7744

Reduction of Lease Liability: 4978.6856

Lease Liability: -44331.5056

Depreciation Expense: $5,000

Date: 31/12/2019

Annual Payment: $6,121.98

Interest Expense: -3546.520448

Reduction of Lease Liability: - 44331.5056

Lease Liability: 0

Depreciation Expense: $5,000

(b) Consumer Price index means: book the same amount year to year for payment. The increase in CPI may be booked as an expense when incurred.

Answer (a)

  Prepare DU Journeys' journal entries for 2016, 2017, and 2018

Date            Account Title and Explanation    Debit($)     Credit($)

31/12/2016  Right of Use asset                          15,000

                  Lease Liability                                                    15,000

31/12/2017  Interest Expense                             1,200

                 Lease Liability                                 4,352.82

                 Cash                                                                    5,552.82

31/12/2017  Amortization Expense                     5,000

                 Right of use Asset                                               5,000

31/12/2018 Interest Expense                               851.77

                Lease Liability                                   4,978.69

                Cash                                                                      5,830.46

31/12/2018 Amortization Expense                      5,000

                Right of use Asset                                                 5,000

 

Answer B:

  • The CPI means he reserves the same amount of payment each year.
  • An increase of  VPI can be recorded as an expense when incurred.

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