January 1, 2008 Doss Company contracts to lease equipment for 5 years, agreeing to make a payment of $94,732 (including the executory costs of 6,000 a year) at the beginning of each year, starting January 1, 2008. The taxes, the insurance, and the maintenance, estimated at $6000 per year, are the obligations of the lessee. The leased equipment is to be capitalized at $370000. The asset is to be amortized on a double-declining balance basis, and the obligation is to be reduced on an effective-interest basis. Doss's incremental borrowing rate is 12% and the implicit rate in the lease is 10%, which is known by Doss. Title to the equipment transfers to Doss when the lease expires. The asset has and estimated useful life of 5 years and no residual value.
(a) Explain the probable relationship of the $370,000 amount to the lease arrangement.
(b) Prepare the journal entry or entries that should be recorded on January 1, 2008, by Charlie Doss Company.
(c) Prepare the journal entry to record depreciation of the leased asset for the year 2008.
(d) Prepare the journal entry to record the interest expense for the year 2008.
(e) prepare the journal entry to record the lease payment of January 1, 2009, assuming reversing entries are not made.
(f) What amounts will appear on the lessee's December 31, 2008 balance sheet relative to the lease contract?
This solution presents the journal entries related to a capital lease.
Journal Entries and Balance Sheet: Cascade Industries and Hardy
(Lessee-Lessor Entries, Balance Sheet Presentation; Sales-Type Lease)
Cascade Industries and Hardy Inc. enter into an agreement that requires Hardy Inc. to build three diesel-electric engines to Cascade's specifications. Upon completion of the engines, Cascade has agreed to lease them for a period of 10 years and to assume all costs and risks of ownership. The lease is noncancelable, becomes effective on January 1, 2008, and requires annual rental payments of $620,956 each January 1, starting January 1, 2008.
Cascade's incremental borrowing rate is 10%. The implicit interest rate used by Hardy Inc. and known to Cascade is 8%. The total cost of building the three engines is $3,900,000. The economic life of the engines is estimated to be 10 years, with residual value set at zero. Cascade depreciates similar equipment on a straight-line basis. At the end of the lease, Cascade assumes title to the engines. Collectibility of the lease payments is reasonably certain; no uncertainties exist relative to unreimbursable lessor costs.
(Round all numbers to the nearest dollar.)
1. Discuss the nature of this lease transaction from the viewpoints of both lessee and lessor.
2. Prepare the journal entry or entries to record the transaction on January 1, 2008, on the books of Cascade Industries.
3. Prepare the journal entry or entries to record the transaction on January 1, 2008, on the books of Hardy Inc.
4. Prepare the journal entries for both the lessee and lessor to record the first rental payment on January 1, 2008.
5. Prepare the journal entries for both the lessee and lessor to record interest expense (revenue) at December 31, 2008. (Prepare a lease amortization schedule for 2 years.)
6. Show the items and amounts that would be reported on the balance sheet (not notes) at December 31, 2008, for both the lessee and the lessor.