Question

Assume that on December 31, 2019, Skysong Aerospace signs a 8-year, non-cancelable lease agreement to lease a hanger from Aero Field Management Company. The following information pertains to this lease agreement:

1. The agreement requires equal rental payments of $159,834 beginning on December 31, 2019.
2. The fair value of the building on December 31, 2019 is $1,083,208.
3. The building has an estimated economic life of 10 years, a guaranteed residual value of $49,600, and an expected residual value of $34,900. Skysong depreciates similar buildings on the straight-line method.
4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor.
5. Skysong’s incremental borrowing rate is 6% per year. The lessor’s implicit rate is not known by Skysong.
Prepare the journal entries on the lessee’s books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2019, 2020, and 2021. Skysong’s fiscal year-end is December 31.

Answer 1

Step-by-step explanation:

a) Journal entry to record signing of lease agreement on December 31, 2019:

Lease receivable $1,083,208

Lease liability $1,083,208

b) Journal entry to record first rental payment on December 31, 2019:

Lease liability $129,787

Cash $129,787

(We calculate the rental payment as the present value of the lease payments of $159,834 for 8 years discounted at 6%, which is $1,083,208. We then divide this by the present value of an annuity due of $1 at 6% for 8 periods, which is 5.33569, to get the rental payment of $202,638. We divide this by 1.56509 to get the semiannual rental payment of $129,787.)

c) Journal entry to record interest expense on December 31, 2020:

Lease liability $66,271

Interest expense $66,271

(We calculate the interest expense as the beginning lease liability of $974,584 times the interest rate of 6%.)

d) Journal entry to record termination of lease on December 31, 2021:

Lease liability $167,044

Leasehold improvement $983,164

Loss on termination of lease $66,000

Cash $1,049,200

(We calculate the lease liability as the present value of the remaining lease payments of $797,376 discounted at 6% for 2 years, which is $667,044. We then add the guaranteed residual value of $49,600 to get the total liability of $716,644. We subtract this from the carrying amount of the building, which is its fair value of $1,083,208 less accumulated depreciation of $50,400 (depreciation expense of $107,880 divided by 2 years), to get the gain or loss on termination of lease of $316,164. We subtract the expected residual value of $34,900 from the carrying amount of the building to get the leasehold improvement of $983,164. Finally, we debit cash for the remaining lease payments of $797,376 plus the accrued interest of $66,000.)