Question

Laura Leasing Company signs an agreement on January 1, 2020, to lease equipment to Larkspur Company. The following information relates to this agreement.

1. The term of the non-cancelable lease is 3 years with no renewal option. The equipment has an estimated economic life of 5 years.
2. The fair value of the asset at January 1, 2020, is $85,000.
3. 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 $5,000, none of which is guaranteed.
4. The agreement requires equal annual rental payments of $27,911 to the lessor, beginning on January 1, 2020.
5. The lessee’s incremental borrowing rate is 5%. The lessor’s implicit rate is 4% and is unknown to the lessee.
6. Larkspur uses the straight-line depreciation method for all equipment.
a. Prepare an amortization schedule that would be suitable for the lessee for the lease term.
LARKSPUR COMPANY (Lessee)
Lease Amortization Schedule
Date Annual Lease
Payment Interest on
Liability Reduction of Lease
Liability Lease Liability
1/1/20 enter a dollar amount
1/1/21 enter a dollar amount
1/1/22 enter a dollar amount
b. Prepare all of the journal entries for the lessee for 2020 and 2021 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. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,265. Record journal entries in the order presented in the problem.)

Answer 1

To prepare an amortization schedule for the lessee, calculate interest expense, reduction of the lease liability, and the lease liability amount for each year. Record the lease agreement, lease payments, and lease expenses for the lessee using appropriate journal entries.

Step-by-step explanation:

a. To prepare an amortization schedule for the lessee for the lease term, we need to calculate the interest expense, reduction of the lease liability, and the lease liability amount for each year. The annual lease payment is $27,911, the interest on the liability can be calculated using the lessee’s incremental borrowing rate of 5%, and the reduction of the lease liability is the annual lease payment minus the interest expense. Here's an example of how the amortization schedule could look:

DateAnnual Lease PaymentInterest on LiabilityReduction of Lease LiabilityLease Liability1/1/20$27,911$-$-$202,556.981/1/21$27,911$8,102.28$19,808.72$182,748.261/1/22$27,911$7,309.93$20,601.07$162,147.19

b. To record the lease agreement, lease payments, and lease expenses for the lessee, we need to make several journal entries. Here are the relevant journal entries for 2020 and 2021:

2020:

1. The lessee should record the lease agreement by debiting the Lease Receivable account and crediting the Lease Liability account for the present value of the lease payments. The entry would be:

• Lease Receivable $202,556.98
• Lease Liability $202,556.98

1. For the annual lease payment, the lessee should debit the Lease Liability account and credit Cash for the amount paid. The entry would be:

• Lease Liability $27,911
• Cash $27,911

2021:

1. For the second annual lease payment, the lessee should again debit the Lease Liability account and credit Cash for the amount paid, as well as record the interest expense and reduction of the lease liability. The journal entry would be:

• Lease Liability $19,808.72
• Interest Expense $8,102.28
• Reduction of Lease Liability $19,808.72
• Cash $27,911

These journal entries should be recorded in the order presented in the problem.