Chapter 20, Problem

1.

To determine

Record the lease and the receipt of the second and third instalments of $2,000 in Company A’s books of accounts.

Explanation of Solution

Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.

Sale type Lease: In a Sales-Type lease, the lessor sells the asset to the lessee and records a receivable. In this type of lease, the lessor records a dealer’s or manufacturer’s profit or loss depending upon the difference between the fair value of the asset and the carrying value of the asset.

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit: Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Record the lease and the receipt of the second and third instalments of $2,000 in Company A’s books of accounts:

Summary Table
Lessee Company
	Lease payment required	Interest at 1% 0n Unpaid Obligation	Balance of Lease Obligation
Lessor Company
Date	Lease Rental Collected	Interest at 1% on Net Investment	Net Investment
Beginning of 1st month			$60,817
Beginning of 1st month	$2,000	$0	$58,817
End of 1st month	0	$588	$59,405
Beginning of 2nd  month	$2,000	0	$57,405
End of 2nd month	0	$574	$57,979
Beginning of 3rd  month	$2,000	0	$55,979
End of 3rd month	0	$560	$56,539

Table (1)

Notes:

$\begin{array}{l}\text{Net Investment = Lease receivanble balance}-\text{Unearned interest}\\ \text{Interest on net investment}\left(\text{end of first month}\right)\text{ = \$58,817}\times \text{1\%}\end{array}$

Prepare the journal entries to record the lease and the receipt of the second and third instalments of $2,000 in Company A’s books of accounts:

Date	Accounts title and explanation	Post Ref.	Debit($)	Credit($)
At inception	Lease Receivable		$72,000
	Sales $\left(\$58,817+\$2,000\right)$			$60,817
	Unearned Interest: Leases $\left(\$72,000-\$60,817\right)$			$11,183
	(To record the sales-type lease at inception)
At inception	Cost of Asset Leased		$50,000
	Speciality Equipment			$50,000
	(To record the cost of the asset leased)
Initial receipt	Cash		$2,000
	Lease Receivable			$2,000
	(To record the receipt of lease payment)
At the end of 1st month	Unearned Interest: Leases		$588
	Interest Revenue			$588
	(To recognize the interest revenue of the year)
Second instalment	Cash		$2,000
	Lease Receivable			$2,000
	(To record the receipt of lease payment)
At the end of 2nd  month	Unearned Interest: Leases		$574
	Interest Revenue			$574
	(To recognize the interest revenue of the year)
Third instalment	Cash		$2,000
	Lease Receivable			$2,000
	(To record the receipt of lease payment)
At the end of 3rd  month	Unearned Interest: Leases		$560
	Interest Revenue			$560
	(To recognize the interest revenue of the year)

Table (2)

2.

To determine

Record the lease and the payment of the second and third instalments of $2,000 in Company B’s books of accounts and monthly depreciation in Company B’s accounts.

Explanation of Solution

Compute the present value of the lease payments:

$\begin{array}{c}\text{Present value of lease payments = Lease payment (Initial)}\text{+}\{\begin{array}{l}\text{Present}\text{value of remaining 35 }\\ \text{payments of \$2,000 each at 1\%}\end{array}\\ =\$2,000+\$\$58,817\\ =\$60,817\end{array}$

Prepare the journal entries to record the lease and the receipt of the second and third instalments of $2,000 in Company B’s books of accounts:

Date	Accounts title and explanation	Post Ref.	Debit($)	Credit($)
At Inception	Leased Equipment		$60,817
	Capital Lease Obligation			$60,817
	(To record thecapital lease at inception)
Initial payment	Capital Lease Obligation		$2,000
	Cash			$2,000
	(To record the capital lease payment)
At the end of 1st month	Depreciation Expense-Lease Equipment		$1,689
	Accumulated depreciation-Equipment			$1,689
	(To record the depreciation expense of the year)
At the end of 1st month	Interest Expense		$588
	Accrued Interest on capital lease obligation			$588
	(To record the interest expense of the lease )
Second instalment	Capital Lease Obligation		$1,412
	Accrued interest on capital lease obligation		$588
	Cash			$2,000
	(To record the capital lease payment)
At the end of 2nd month	Depreciation Expense-Lease Equipment		$1,689
	Accumulated depreciation-Equipment			$1,689
	(To record the depreciation expense of the year)
At the end of 2nd month	Interest Expense		$574
	Accrued Interest on capital lease obligation			$574
	(To record the interest expense of the lease )
3rd instalment	Capital Lease Obligation		$1,426
	Accrued interest on capital lease obligation		$574
	Cash			$2,000
	(To record the capital lease payment)
At the end of 3rd month	Depreciation Expense-Lease Equipment		$1,689
	Accumulated depreciation-Equipment			$1,689
	(To record the depreciation expense of the year)
At the end of 3rd month	Interest Expense		$560
	Accrued Interest on capital lease obligation			$560
	(To record the interest expense of the lease )

Table (3)