Question

Cinci Co. leased equipment for its entire 10-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, Year 1, and $50,000 annually on each December 31 for the next 9 years. The present value on December 31, Year 1, of the ten lease payments was $337,951. The interest rate for both the lessee and the lessor was 10%. The December 31, Year 1, present value of the lease payments using Allen's incremental borrowing rate of 12% was $298,500. Allen made timely first and second lease payments.

Required:
What amount should Allen report as capital lease liability in its December 31, Year 2, balance sheet?

Answer 1

The amount that Allen should report as capital lease liability in its December 31, Year 2, balance sheet is $266,746.

Step-by-step explanation:

From the question, it can be seen that 10% is used by the lessee. The reason is that the 10% is what is known by the lessee and it is also lower than 12%. Therefore, we have:

Balance of the lease liability after the first payment = Present value on December 31 of Year 1 - Amount of the first payment = $337,951 - $50,000 = $287,951

It should noted that there is no interest in the amount of the first payment as it was an immediate payment.

Interest expense in Year 2 = 10% * Balance of the lease liability after the first payment = 10% * 287,951 = $28,795

Lease liability paid in Year 2 = Cash paid - Interest expense in Year 2 = $50,000 - $28,795 = $21,205

The journal entries at December 31, Year 2 will then be as follows:

Accounts Title Debit ($) Credit ($)

Lease liability 21,205

Interest expense 28,795

Cash 50,000

(To record lease payment.)

Therefore, we have:

Capital lease liability on December 31 of Year 2 = Balance of the lease liability after the first payment - Lease liability paid in Year 2 = $287,951 - $21,205 = $266,746

Therefore, the amount that Allen should report as capital lease liability in its December 31, Year 2, balance sheet is $266,746.