Question

Braun Company signs a five-year capital lease with Verdi Company for office equipment. The annual year-end lease payment is \(20,000, and the interest rate is 10%.

Required

1. Compute the present value of Braun’s lease payments.
2. Prepare the journal entry to record Braun’s capital lease at its inception.
3. Complete a lease payment schedule for the five years of the lease with the following headings. Assume that the beginning balance of the lease liability (present value of lease payments) is \)75,816. (Hint: To find the amount allocated to interest in year 1, multiply the interest rate by the beginning-of-year lease liability. The amount of the annual lease payment not allocated to interest is allocated to principal. Reduce the lease liability by the amount allocated to principal to update the lease liability at each year-end.)

Period ending date	Beginning balance of lease liability	Interest on lease liability	Reduction on lease liability	Cash lease payment	Ending balance of lease liability

4. Use straight-line depreciation and prepare the journal entry to depreciate the leased asset at the end of year 1. Assume zero salvage value and a five-year life for the office equipment.

Short answer

Braun Company signs a five-year capital lease with Verdi Company for office equipment. The annual year-end lease payment is $20,000, and the interest rate is 10%.

Required

1. Compute the present value of Braun’s lease payments.
2. Prepare the journal entry to record Braun’s capital lease at its inception.
3. Complete a lease payment schedule for the five years of the lease with the following headings. Assume that the beginning balance of the lease liability (present value of lease payments) is $75,816. (Hint: To find the amount allocated to interest in year 1, multiply the interest rate by the beginning-of-year lease liability. The amount of the annual lease payment not allocated to interest is allocated to principal. Reduce the lease liability by the amount allocated to principal to update the lease liability at each year-end.)

Period ending date	Beginning balance of lease liability	Interest on lease liability	Reduction on lease liability	Cash lease payment	Ending balance of lease liability

4. Use straight-line depreciation and prepare the journal entry to depreciate the leased asset at the end of year 1. Assume zero salvage value and a five-year life for the office equipment.

Step-by-step solution

Explanation on leasing

Leasing is the agreement between the lessor (asset owner) and a lessee (asset renter or tenant), which provides rights of using the asset to lesse without owning it.

(1) Present value of Rogers’s five-year lease payments

Lease amount =$20,000

Interest rate= 10%

Period= 5 year

Table value (B3)= 3.7908

$\begin{array}{c}\mathbf{P}\mathbf{r}\mathbf{e}\mathbf{s}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{}\mathbf{v}\mathbf{a}\mathbf{l}\mathbf{u}\mathbf{e}\mathbf{=}\mathbf{L}\mathbf{e}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{p}\mathbf{a}\mathbf{y}\mathbf{m}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{\times }\mathbf{\text{Tablefactor}}\\ \mathbf{=}\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{3}\mathbf{.7908}\\ \mathbf{=}\mathbf{\$}\mathbf{75}\mathbf{,}\mathbf{816}\end{array}$

(2) Journal entry to record capital lease

Leased asset	$20,000
Leased liability		$20,000
Record lease asset and liability

(3) Lease payment schedule

Payments
	A	B	C	D	E
Year	Beginning balance of lease liability	Interest on lease liability 10% of (A)	Reduction on lease liability (D)-(B)	Cash lease payment (B)+(C)	Ending balance of lease liability (A)-(C)
1	75,816	7,582	12,418	20,000	63,398
2	63,398	6,340	13,660	20,000	49,738
3	49,738	4,974	15,026	20,000	34,712
4	34,712	3,471	16,529	20,000	18,183
5	18,183	1,817	18,183	20,000	0

(4) Journal entry to record depreciation        

Depreciation expense- leased asset	$4,000
Accumulated depreciation- leased asset		$4,000
Record depreciation

Calculation of depreciation expense:

$\begin{array}{c}\mathbf{D}\mathbf{e}\mathbf{p}\mathbf{r}\mathbf{e}\mathbf{c}\mathbf{i}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{n}\mathbf{=}\frac{\mathbf{C}\mathbf{o}\mathbf{s}\mathbf{t}\mathbf{-}\mathbf{S}\mathbf{a}\mathbf{l}\mathbf{v}\mathbf{a}\mathbf{g}\mathbf{e}\mathbf{}\mathbf{v}\mathbf{a}\mathbf{l}\mathbf{u}\mathbf{e}}{\mathbf{U}\mathbf{s}\mathbf{e}\mathbf{f}\mathbf{u}\mathbf{l}\mathbf{}\mathbf{l}\mathbf{i}\mathbf{f}\mathbf{e}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{0}}{\mathbf{5}}\\ \mathbf{=}\mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{000}\end{array}$