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Chapter 21: 5BE (page 1240)

Jana Kingston Corporation enters into a lease on January 1, 2017, that does not transfer ownership or contain a bargain-purchase option. It covers 3 years of the equipment’s 8-year useful life, and the present value of the minimum lease payments is less than 90% of the fair value of the asset leased. Prepare Jana Kingston’s journal entry to record its January 1, 2017, annual lease payment of $35,000.

Short Answer

Expert verified

Rent expense should be debited and the cash account should be credited with the amount of $35,000.

Step by step solution

01

Meaning of Bargain purchase option

A bargain purchase option may be a clause in a rent agreement that grants the tenant to purchase the rented thingfor essentially less than its reasonable market value on the lease's termination date. When this alternative is accessible, the tenant is ordinarily obliged to handle the renting agreement as a finance lease, in which the rented resource is perceived on the lessee's claim balance sheet.

02

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
	Rent Expense	35,000
	Cash		35,000

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Most popular questions from this chapter

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
The cost of the asset to the lessor is $245, 000. T h e f a i r v a l u e o f t h e a s s e t a t J a n u a r y 1, 2017, i s$ 245,000.
The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
Cole Company assumes direct responsibility for all executory costs.
The agreement requires equal annual rental payments, beginning on January 1, 2017.
Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(a) Assuming the lessor desires a 10% rate of return on its investment, calculate the amount of the annual rental payment required. (Round to the nearest dollar.)

Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
The cost of the machinery is $525, 000, a n d t h e f a i r v a l u e o f t h e a s s e t o n J a n u a r y 1, 2017, i s$ 700,000.
At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight-line basis.
The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.

Instructions

(Assume the accounting period ends on December 31.)

Discuss the nature of this lease for both the lessee and the lessor.

(Operating Lease for Lessee and Lessor) On February 20, 2017, Barbara Brent Inc. purchased a machine for $1, 500, 000 f o r t h e p u r p o s e o f l e a s i n g i t . T h e m a c h i n e i s e x p e c t e d t o h a v e a 10 - y e a r l i f e, n o r e s i d u a l v a l u e, a n d w i l l b e d e p r e c i a t e d o n t h e s t r a i g h t - l i n e b a s i s . T h e m a c h i n e w a s l e a s e d t o R u d y C o m p a n y o n M a r c h 1, 2017, f o r a 4 - y e a r p e r i o d a t a m o n t h l y r e n t a l o f$ 19,500. There is no provision for the renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. Brent paid $30,000 of commissions associated with negotiating the lease in February 2017.

Instructions

(b) What income or loss before income taxes should Brent record as a result of the facts above for the year ended December 31, 2017? (Hint: Amortize commissions over the life of the lease.)

Winston Industries and Ewing Inc. enter into an agreement that requires Ewing Inc. to build three diesel-electric engines to Winston’s specifications. Upon completion of the engines, Winston has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2017, and requires annual rental payments of \(413,971 each January 1, starting January 1, 2017.

Winston’s incremental borrowing rate is 10%. The implicit interest rate used by Ewing Inc. and known to Winston is 8%. The total cost of building the three engines is \)2,600,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Winston depreciates similar equipment on a straight-line basis. At the end of the lease, Winston assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.

Instructions

(c) Prepare the journal entry or entries to record the transaction on January 1, 2017, on the books of Ewing Inc.

Assume that IBM leased equipment that was carried at a cost of $150, 000 t o S h a r o n S w a n d e r C o m p a n y . T h e t e r m o f t h e l e a s e i s 6 y e a r s b e g i n n i n g J a n u a r y 1, 2017, w i t h e q u a l r e n t a l p a y m e n t s o f$ 30,044 at the beginning of each year. All executory costs are paid by Swander directly to third parties. The fair value of the equipment at the inception of the lease is $150,000. The equipment has a useful life of 6 years with no salvage value. The lease has an implicit interest rate of 8%, no bargain-purchase option, and no transfer of title. Collectibility is reasonably assured with no additional cost to be incurred by IBM. Prepare IBM’s January 1, 2017, journal entries at the inception of the lease.

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