E21-311: Additional Practice Exercises

ACCT-311: Additional Practice exercises from Chapter 21 (textbook)
Comprehensive problem:
E21-11 (Amortization Schedule and Journal Entries for Lessee) Grady Leasing Company signs an agreement on January 1, 2012, to lease equipment to Azure Company. The following information relates to this agreement.
1. The term of the noncancelable lease is 5 years with no renewal option. The equipment has an estimated economic life of 5 years.
2. The fair value of the asset at January 1, 2012, is $90,000.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $7,000, none of which is guaranteed.
4. Azure Company assumes direct responsibility for all executory costs, which include
the following annual amounts: (1) $900 to Frontier Insurance Company for insurance and (2) $1,600 to Crawford
County for property taxes.
5. The agreement requires equal annual rental payments of $20,541.11 to the lessor, beginning on
January 1, 2012.
6. The lessee’s incremental borrowing rate is 12%. The lessor’s implicit rate is 10% and is known to the lessee. 7. Azure Company uses the straight-line depreciation method for all equipment.
8. Azure uses reversing entries when appropriate.

Instructions
(Round all numbers to the nearest cent.)
(a) Prepare an amortization schedule that would be suitable for the lessee for the lease term.
(b) Prepare all of the journal entries for the lessee for 2012 and 2013 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31.

Solutions:

EXERCISE 21-11

Note: This lease is a capital lease to the lessee because the lease term
(five years) exceeds 75% of the remaining economic life of the asset (five years). Also, the present value of the minimum lease payments exceeds 90% of the fair value of the
asset.

$20,541.11 Annual rental payment X 4.16986 PV of an annuity due of 1 for n = 5, i = 10% $85,653.55 PV of minimum lease payments

(a) AZURE COMPANY (Lessee) Lease Amortization Schedule

Date

Annual Lease Payment

Interest (10%) on Liability
Reduction of Lease Liability

Lease Liability
1/1/12

$85,653.55
1/1/12
$ 20,541.11

$20,541.11
65,112.44
1/1/13
20,541.11
*$ 6,511.24
14,029.87
51,082.57
1/1/14
20,541.11
5,108.26
15,432.85
35,649.72
1/1/15
20,541.11
3,564.97
16,976.14
18,673.58
1/1/16
20,541.11
* 1,867.53* 18,673.58
0

$102,705.55
*$17,052.00
$85,653.55

*Rounding error is 17 cents.

(b) 1/1/12 Leased Equipment 85,653.55 Lease Liability 85,653.55

1/1/12 Lease Liability 20,541.11 Cash 20,541.11

During 2012

Insurance Expense 900.00 Cash 900.00

Property Tax Expense 1,600.00 Cash 1,600.00

12/31/12 Interest Expense 6,511.24 Interest Payable 6,511.24

Depreciation Expense 17,130.71 Accumulated Depreciation— Capital Leases 17,130.71 ($85,653.55 ÷ 5 = $17,130.71)

1/1/13 Interest Payable 6,511.24 Interest Expense 6,511.24

Interest Expense 6,511.24 Lease Liability 14,029.87 Cash 20,541.11

During 2013

Insurance Expense 900.00 Cash 900.00

Property Tax Expense 1,600.00 Cash 1,600.00

12/31/13 Interest Expense 5,108.26 Interest Payable 5,108.26

Depreciation Expense 17,130.71 Accumulated Depreciation— Capital Leases 17,130.71

Note:

1.
The lessor sets the annual rental payment as follows:

Fair value of leased asset to lessor $90,000.00 Less: Present value of unguaranteed residual value $7,000 X .62092 (present value of 1 at 10% for 5 periods) 4,346.44 Amount to be recovered through lease payments $85,653.56 Five periodic lease payments $85,653.56 ÷ 4.16986* $20,541.11

*Present value of annuity due of 1 for 5 periods at
10%.