Question

Indiana Jones Corporation enters into a 6-year lease of equipment on January 1, 2017, which requires 6 annual payments of \(40,000 each, beginning January 1, 2017. In addition, Indiana Jones guarantees the lessor a residual value of \)20,000 at lease-end. The equipment has a useful life of 6 years. Prepare Indiana Jones’ January 1, 2017, journal entries assuming an interest rate of 10%.

Short answer

PV of rentals is $91,632

PV of Guarantees residual value is $11,289

Step-by-step solution

Meaning of Lease

A Lease refers to a lawful mutual agreement in which the lessor transfers the right to use the property to the lessee. The lessee must pay lease liability to the lessor as mentioned in the lease agreement.

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
	Leased Equipment	202,921
	Lease Liability		202,921
	Lease Liability	40,000
	Cash		40,000

Working Notes:-

Calculation of Leased Equipment amount

PV of rentals	$191,632
PV of guarantees residual value	11,289
	$202,921

$$\begin{gathered} \mathrm{PV}\mathrm{of}\mathrm{rentals}=\mathrm{Annual}\mathrm{payments}\times \mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{annuity} \\ =\$40,000\times 4.79079 \\ =\$191.632 \end{gathered}$$

role="math" localid="1650004923096" $$\begin{gathered} \mathrm{PV}\mathrm{of}\mathrm{guarantees}\mathrm{residual}\mathrm{value}=\mathrm{Residual}\mathrm{value}\times \mathrm{Present}\mathrm{value} \\ =\$20,000\times 0.56447 \\ =\$11.289 \end{gathered}$$

Note: Present value of an annuity due of 1 for 6 periods at 10%

Present value of 1 for 6 periods at 10%