Chapter 15, Problem 15.16E

Lessee; operating lease

• LO15–4

Grichuk Power leased high-tech electronic equipment from Kolten Leasing on January 1, 2018. Kolten purchased the equipment from Wong Machines at a cost of $250,000, its fair value.

Related Information:
Lease term	2 years (8 quarterly periods)
Quarterly lease payments	$15,000 at Jan. 1, 2018, and at Mar. 31, June 30, Sept. 30, and Dec. 31 thereafter
Economic life of asset	5 years
Interest rate charged by the lessor	8%

Required:

Prepare appropriate entries for Grichuk Power from the beginning of the lease through December 31, 2018. December 31 is the fiscal year end for each company. Appropriate adjusting entries are recorded at the end of each quarter.

To determine

Operating lease

This type of lease refers to the lease where the lessor permits the lessee to make use of the asset for a specified time period by charging rent without actual transfer of ownership of the asset which is leased. This type of lease cancellable and is of short term.

To prepare: appropriate entries for Company GP (Lessee) from the beginning of lease through December 31, 2018.

Explanation of Solution

Prepare journal entry for Company GP in the month of January 1, 2018

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
January	1	Right-of-use asset (1)		112,080
		Lease Payable			112,080
		(To record the lease payable)

Table (1)

Explanation:

• Right-of-use asset is an asset. There is an increase in asset. Therefore, debit right-of-use asset account by $112,080.
• Lease payable is a liability. There is a increase in liability. Therefore, credit lease liability by $112,080.

Transaction on January 1, 2018: Record the quarterly lease payments.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Lease payable		15,000
	Cash			15,000
	(To record quarterly lease payment.)

Table (2)

Explanation:

• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $15,000.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $15,000.

Transaction on March 31, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (2)		1,942
	Lease payable (Difference)		13,058
	Cash			15,000
	(To record quarterly lease payment and interest expenses.)

Table (3)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $1,942.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $13,058.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $15,000.

Transaction on March 31, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (3)		13,058
	Right-of-use asset			13,058
	(To record amortization expense.)

Table (4)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $13,058.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $13,058.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Transaction on June 30, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (4)		1,681
	Lease payable (Difference)		13,319
	Cash			15,000
	(To record quarterly lease payment and interest expenses.)

Table (5)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $1,681.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $13,319.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $15,000.

Transaction on June 30, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (5)		13,319
	Right-of-use asset			13,319
	(To record amortization expense.)

Table (6)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $13,319.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $13,319.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Transaction on September 30, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (6)		1,414
	Lease payable (Difference)		13,586
	Cash			15,000
	(To record quarterly lease payment and interest expenses.)

Table (7)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $1,414.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $13,586.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $15,000.

Transaction on September 30, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (7)		13,586
	Right-of-use asset			13,586
	(To record amortization expense.)

Table (8)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $13,586.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $13,586.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Transaction on December 31, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (8)		1,142
	Lease payable (Difference)		13,858
	Cash			15,000
	(To record quarterly lease payment and interest expenses.)

Table (9)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $1,142.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $13,858.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $15,000.

Transaction on December 31, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (9)		13,858
	Right-of-use asset			13,858
	(To record amortization expense.)

Table (10)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $13,858.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $13,858.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Working notes:

The number of years is taken as 8 quarters $\left[2\text{years}\times 4\right]$ as interest is calculated quarterly. The interest rate is calculated as 2% $\left[\frac{8\%}{4}\right]$ as interest is calculated for quarterly.

Use the present value factor 7.47199 (Present value factor $1 for 8 quarters at 2% rate) for calculating present value of lease payments.

Calculate the present value of lease payments as follows:

$\begin{array}{c}\begin{array}{l}\text{Present value }\\ \text{of lease payments}\end{array}\}\text{ =Quarterly lease payments}\times \text{PVIFA}\left(2\%,8\right)\\ \text{=}\text{\$15,000}\times 7.47199\\ =\$112,080\end{array}$ (1)

Calculate the amount of interest expense for March 31, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \left(\begin{array}{l}\text{Lease liability initial balance}\\ -\text{First quarterly payment}\end{array}\right)\\ =2\text{\%}\times \left(\$112,080\left(1\right)-\$15,000\right)\\ =\$1,942\end{array}$ (2)

Calculate the amortization expense for March 31, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Quarterly lease payments}-\text{Interest expense}\\ =\$15,000-\$1,942\left(2\right)\\ =\$13,058\end{array}$ (3)

Calculate the amount of interest expense for June 30, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \left(\begin{array}{l}\text{Lease liability initial balance}\\ -\text{quarterly payment}\\ -\text{Amortization expense, March 31}\end{array}\right)\\ =2\text{\%}\times \left(\$112,080\left(1\right)-\$15,000-\$13,058\left(3\right)\right)\\ =\$1,681\end{array}$ (4)

Calculate the amortization expense for June 30, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Quarterly lease payments}-\text{Interest expense}\\ =\$15,000-\$1,681\left(4\right)\\ =\$13,319\end{array}$ (5)

Calculate the amount of interest expense for September 30, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \left(\begin{array}{l}\text{Lease liability initial balance}\\ -\text{quarterly payment}\\ -\text{Amortization expense, March 31}\\ -\text{ Amortization expense, June 30}\end{array}\right)\\ =2\text{\%}\times \left(\$112,080\left(1\right)-\$15,000-\$13,058\left(3\right)-\$13,319\left(5\right)\right)\\ =\$1,414\end{array}$ (6)

Calculate the amortization expense for September 30, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Quarterly lease payments}-\text{Interest expense}\\ =\$15,000-\$1,414\left(6\right)\\ =\$13,586\end{array}$ (7)

Calculate the amount of interest expense for December 31, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \left(\begin{array}{l}\text{Lease liability initial balance}\\ -\text{quarterly payment}\\ -\text{Amortization expense, March 31}\\ -\text{Amortization expense, June 30}\\ -\text{ Amortization expense, September 30}\end{array}\right)\\ =2\text{\%}\times \left(\begin{array}{l}\$112,080\left(1\right)-\$15,000-\$13,058\left(3\right)\\ -\$13,319\left(5\right)-\$13,586\left(7\right)\end{array}\right)\\ =\$1,142\end{array}$ (8)

Calculate the amortization expense for December 31, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Quarterly lease payments}-\text{Interest expense}\\ =\$15,000-\$1,142\left(8\right)\\ =\$13,858\end{array}$ (9)