Question

On July 1, 2012, Falk Company signed a contract to lease space in a building for 15 years. The lease contract calls for annual (prepaid) rental payments of \(80,000 on each July 1 throughout the life of the lease and for the lessee to pay for all additions and improvements to the leased property. On June 25, 2017, Falk decides to sublease the space to Ryan & Associates for the remaining 10 years of the lease—Ryan pays \)200,000 to Falk for the right to sublease and it agrees to assume the obligation to pay the \(80,000 annual rent to the building owner beginning July 1, 2017. After taking possession of the leased space, Ryan pays for improving the office portion of the leased space at a \)130,000 cost. The improvements are paid for by Ryan on July 5, 2017, and are estimated to have a useful life equal to the 16 years remaining in the life of the building.

Required

1. Prepare entries for Ryan to record (a) its payment to Falk for the right to sublease the building space, (b) its payment of the 2017 annual rent to the building owner, and (c) its payment for the office improvements.
2. Prepare Ryan’s year-end adjusting entries required at December 31, 2017, to (a) amortize the $200,000 cost of the sublease, (b) amortize the office improvements, and (c) record rent expense.

Short answer

1. The leasehold account, prepaid rent and leasehold improvement is debited.
2. The amortization expenses and rent expense is debited.

Step-by-step solution

Leaseholds

Property is rented under a contract called a lease. The property’s owner, called the lessor, grants the lease. The one who secures the right to possess and use the property is called the lessee. A leasehold refers to the rights the lessor grants to the lessee under the lease terms. A leasehold is an intangible asset for the lessee.

(1) Journal entries

1. its payment to Falk for the right to sublease the building space
   

   June 25	Leasehold	$200,000
   	Cash		$200,000
   	Record leasehold

2. its payment of the 2017 annual rent to the building owner
   

   July 01	Prepaid rent	$80,000
   	Cash		$80,000
   	Record prepaid rent

3. its payment for the office improvements
   

   July 05	Leasehold improvement	$130,000
   	Cash		$130,000
   	Record leasehold improvement

(2) Journal entries

1. amortize the $200,000 cost of the sublease
   

   Dec 31	Amortization expense	$10,000
   	Accumulated amortization- leasehold		$10,000
   	Record amortization

   
   Note:
   $\begin{array}{rcl}\mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}& \mathbf{=}& \frac{\mathbf{c}\mathbf{o}\mathbf{s}\mathbf{t}\mathbf{-}\mathbf{s}\mathbf{a}\mathbf{l}\mathbf{v}\mathbf{a}\mathbf{g}\mathbf{e}\mathbf{}\mathbf{v}\mathbf{a}\mathbf{l}\mathbf{u}\mathbf{e}}{\mathbf{u}\mathbf{s}\mathbf{e}\mathbf{f}\mathbf{u}\mathbf{l}\mathbf{}\mathbf{l}\mathbf{i}\mathbf{f}\mathbf{e}}\\ \mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{(}\mathbf{f}\mathbf{o}\mathbf{r}\mathbf{}\mathbf{6}\mathbf{}\mathbf{m}\mathbf{o}\mathbf{n}\mathbf{t}\mathbf{h}\mathbf{s}\mathbf{)}& \mathbf{=}& \frac{\mathbf{200}\mathbf{,}\mathbf{000}}{\mathbf{10}\mathbf{\times }\mathbf{2}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{000}\end{array}$
   
2. amortize the office improvements
   

   Dec 31	Amortization expense	$4,063
   	Accumulated amortization- office improvement		$4,063
   	Record amortization

   
   Note:
   $\begin{array}{rcl}\mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}& \mathbf{=}& \frac{\mathbf{cost}\mathbf{-}\mathbf{salvage}\mathbf{}\mathbf{value}}{\mathbf{useful}\mathbf{}\mathbf{life}}\\ \mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{(}\mathbf{for}\mathbf{}\mathbf{6}\mathbf{}\mathbf{months}\mathbf{)}& \mathbf{=}& \frac{\mathbf{130}\mathbf{,}\mathbf{000}}{\mathbf{16}\mathbf{\times }\mathbf{2}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{063}\end{array}$
   
3. record rent expense
   

   Dec 31	Rent expense	$40,000
   	Accumulated amortization- leasehold		$40,000
   	Record rent expense

   
   Note:
   $\begin{array}{rcl}\mathit{r}\mathit{e}\mathit{n}\mathit{t}\mathbf{}\left(for6month\right)& \mathbf{=}& \frac{\mathbf{80}\mathbf{,}\mathbf{000}}{\mathbf{2}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{40}\mathbf{,}\mathbf{000}\end{array}$