Question

Question: (Lessee Entries and Balance Sheet Presentation, Capital Lease) On January 1, 2017, Cage Company contracts to lease equipment for 5 years, agreeing to make a payment of \(137,899 (including the executory costs of \)6,000) at the beginning of each year, starting January 1, 2017. The taxes, the insurance, and the maintenance, estimated at \(6,000 a year, are the obligations of the lessee. The leased equipment is to be capitalized at \)550,000. The asset is to be depreciated on a double-declining-balance basis, and the obligation is to be reduced on an effective-interest basis. Cage’s incremental borrowing rate is 12%, and the implicit rate in the lease is 10%, which is known by Cage. Title to the equipment transfers to Cage when the lease expires. The asset has an estimated useful life of 5 years and no residual value.

Instructions

(b) Prepare the journal entry or entries that should be recorded on January 1, 2017, by Cage Company.

Short answer

Lease liability = $550,000.

Step-by-step solution

Meaning of Lease

A lease is a valid bilateral agreement made between the lessor and the lesseefor the transfer of ownership rights to a particular asset for a specific time and amount. The lease is terminated at the end of the lease period.

Preparing journal entries

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Date	Particular	Debit ($)	Credit ($)
	Leased Equipment	550,000
	Lease Liability		550,000
	Executory Costs	6,000
	Lease Liability	131,899
	Cash		137,899

Working Notes:

Calculation of lease liability

$$\begin{gathered} \text{Lease}\text{liability}=\text{Annual}\text{lease}\text{payments}\times \text{Present}\text{value}\text{of}\text{annuity} \\ =\$131,899\times 4.16986 \\ =\$550,000 \end{gathered}$$

$\mathrm{Note}:\mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{Annuity}\mathrm{Due}\mathrm{Factor}\mathrm{for}5\mathrm{years}\mathrm{at}10\%$