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Chapter 21: Q. 21-12E-b (page 1243)

(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.

  1. The lease arrangement is for 10 years.
  2. The leased building cost \(4,500,000 and was purchased for cash on January 1, 2017.
  3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
  4. Lease payments are \)275,000 per year and are made at the end of the year.
  5. Property tax expense of \(85,000 and insurance expense of \)10,000 on the building were incurred by Nelson in the first year. Payment on these two items was made at the end of the year.
  6. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

(b) Prepare the journal entries that Wise Inc. should make in 2017

Short Answer

Expert verified

The rent expense is $275,000.

Step by step solution

01

Meaning of Lease

A lawful agreement made between the lessor and the lessee is called a lease. In a lease, the lessor is the owner of the property whereas the lessee has the right to use the property only as prescribed in the lease agreement.

02

Preparing Journal Entries

Date

Particular

Debit ($)

Credit ($)

Dec. 31, 2017

Rent Expense

275,000

Cash

275,000

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Most popular questions from this chapter

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.

Question: The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee.

Inception date

January 1, 2017

Annual lease payment due at the beginning of each year, beginning with January 1, 2017

\(124,798

Residual value of equipment at end of lease term, guaranteed by the lessee

\)50,000

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at January 1, 2017

\(600,000

Lessor’s implicit rate

12%

Lessee’s incremental borrowing rate

12%

The lessee assumes responsibility for all executory costs, which are expected to amount to \)5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straightline depreciation method for all equipment.

Instructions

(b) Prepare all of the journal entries for the lessee for 2017 and 2018 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31 and reversing entries are used when appropriate.

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

(d) Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2017.

The residual value is the estimated fair value of the leased property at the end of the lease term.

(a) Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessee’s accounting for a capitalized-lease transaction?

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

(a) Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.
See all solutions

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