Question

Rauch Incorporated leases a piece of equipment to Donahue Corporation on January 1, 2017. The lease agreement called for annual rental payments of $4,892 at the beginning of each year of the 4-year lease. The equipment has an economic useful life of 6 years, a fair value of $25,000, a book value of $20,000, and both parties expect a residual value of $8,250 at the end of the lease term, though this amount is not guaranteed. Rauch set the lease payments with the intent of earning a 5% return, and Donahue is aware of this rate. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

Suppose Donahue incurs initial direct costs of $750 related to the lease. Prepare the journal entries for 2017. (Credit account titles are automatically indented when the amount is entered. Do not indent manu

Answer 1

PART-1)

Fair value of leased asset to lessor = 25,000

Minus: PV of un-guaranteed residual value $8,250 X 0.82270 = 6,787

Amount to be recovered through lease payments = 18,213

Four periodic lease payments ($18,213 /3.72325) = 4,892

PART-2)

01/01/2017

Debit: Cash = 4,892

Credit: Unearned Lease Revenue = 4,892

12/31/2017

Debit: Unearned Lease Revenue = 4,892

Credit: Lease Revenue = 4,892

12/31/2017

Debit: Depreciation Expense = 3,333

Credit: Accumulated Depreciation – Equipment = 3,333