Question

On January 1, 2021, NRC Credit Corporation leased equipment to Brand Services under a finance/sales-type lease designed to earn NRC a 10% rate of return for providing long-term financing. The lease agreement specified the following:

Ten annual payments of $73,000 beginning January 1, 2021, the beginning of the lease and each December 31 thereafter through 2029. The estimated useful life of the leased equipment is 10 years with no residual value. Its cost to Lesco was $417,665.The lease qualifies as a finance lease/sales-type lease. A 10-year service agreement with Quality Maintenance Company was negotiated to provide maintenance of the equipment as required. Payments of $7,000 per year are specified, beginning January 1, 2021. Lesco was to pay this cost as incurred, but lease payments reflect this expenditure. Also included in the $73,000 payments is an insurance premium of $6,000 providing coverage for the equipment. A partial amortization schedule, appropriate for both the lessee and lessor, follows:
Decrease in Outstanding
Payments Effective Interest Balance Balance
(10% * Outstanding balance) 412,300
1/1/2021 61,000 351, 300
12/31/2021 61,000 0.1 (351,300) = 35, 130 325,430
12/31/2022 61,000 0.1 (325, 430) = 32,543 296, 973
Required:
1. Prepare the appropriate entries for the lessee related to the lease on January 1, 2021 and December 31, 2021.
2. Prepare the appropriate entries for the lessor related to the lease on January 1, 2021 and December 31, 2021.

Answer 1

The lessee would record the initial lease payment on January 1, 2021 as a decrease in cash and a decrease in the lease liability. On December 31, 2021, the lessee would record the annual lease payment as a decrease in cash and a decrease in the lease liability. The lessor would record the initial lease payment on January 1, 2021 as an increase in lease receivable and an increase in unearned revenue. On December 31, 2021, the lessor would record the annual lease payment as a decrease in unearned revenue and an increase in interest revenue.

Step-by-step explanation:

1. Prepare the appropriate entries for the lessee related to the lease on January 1, 2021 and December 31, 2021.

1. On January 1, 2021, the lessee would record the initial lease payment as a decrease in cash and a decrease in the lease liability. The entry would be:

• Debit Cash $61,000
• Debit Lease Liability $351,300
• Credit Lease Payments $412,300 (which is the sum of the cash paid and the effective interest)

On December 31, 2021, the lessee would record the annual lease payment as a decrease in cash and a decrease in the lease liability. The entry would be:

• Debit Cash $61,000
• Credit Lease Payments $61,000
• Credit Interest Expense $35,130 (which is 10% of the outstanding lease liability at the beginning of the year)
• Debit Lease Liability $35,130

2. Prepare the appropriate entries for the lessor related to the lease on January 1, 2021 and December 31, 2021.

1. On January 1, 2021, the lessor would record the initial lease payment as an increase in lease receivable and an increase in unearned revenue. The entry would be:

• Debit Lease Receivable $412,300
• Debit Unearned Revenue $412,300
• Credit Cash $412,300

On December 31, 2021, the lessor would record the annual lease payment as a decrease in unearned revenue and an increase in interest revenue. The entry would be:

• Debit Unearned Revenue $61,000
• Credit Lease Revenue $35,130 (which is 10% of the outstanding lease receivable at the beginning of the year)
• Credit Interest Revenue $25,870 (which is the difference between the lease revenue and the interest revenue)