Chapter 15, Problem 15.26P

(1)

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 H Consulting (Lessee) to record the right-of-use asset and lease liability at January 1, 2018.

Explanation of Solution

Transaction on January 01, 2018: Record the lease payable.

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Right-of-use asset (1)		16,428
		Lease Payable			16,428
		(To record the lease payable)

Table (1)

Working note:

$\begin{array}{c}\text{Present value of lease payments = }\left[\begin{array}{l}\left(\begin{array}{l}\text{Annual lease payment in 2018}\\ \times \text{ PVIF}\left(5\%,1\right)\end{array}\right)\\ +\left(\begin{array}{l}\text{Annual lease payment in 2019}\\ \times \text{ PVIF}\left(5\%,2\right)\end{array}\right)\\ +\left(\begin{array}{l}\text{Annual lease payment in 2020}\\ \times \text{ PVIF}\left(5\%,3\right)\end{array}\right)\end{array}\right]\\ =\left[\begin{array}{l}\left(\begin{array}{l}\$5,000\\ \times \text{ 0}\text{.86384}\end{array}\right)\\ +\left(\begin{array}{l}\$6,000\\ \times \text{ 0}\text{.90703}\end{array}\right)+\left(\begin{array}{l}\$7,000\\ \times \text{ 0}\text{.95238}\end{array}\right)\end{array}\right]\\ =\$4,319+\$5,442+\$6,667\\ =\$16,428\end{array}$ (1)

Explanation:

• Right-of-use asset is an asset. There is an increase in asset. Therefore, debit right-of-use asset account by $16,428.
• Lease payable is a liability. There is an increase in liability. Therefore, credit lease liability by $16,428.

(2)

To determine

To Prepare: appropriate entries for H Consulting (Lessee) to record the right-of-use asset and lease liability at December 31, 2018.

Explanation of Solution

Transaction on December 31, 2018:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (2)		821
	Lease payable (Difference)		6,179
	Cash			7,000
	(To record annual lease payment and interest expenses.)
	Amortization expense (3)		5,179
	Right-of-use asset			5,179
	(To record amortization expense.)

Table (2)

Working note:

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

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \text{Lease liability initial balance}\\ =5\text{\%}\times \$16,428\\ =\$821\end{array}$ (2)

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

$\begin{array}{c}\text{Amortization expenses = Annual lease payments}-\text{Interest expense}\\ =\$6,000-\$821\left(2\right)\\ =\$5,179\end{array}$ (3)

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

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $821.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $6,179.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $7,000.

Transaction on December 31, 2018: Record amortization expense

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $5,179.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $5,179.

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.

(3)

To determine

To Prepare: appropriate entries for H Consulting (Lessee) to record the right-of-use asset and lease liability at December 31, 2019.

Explanation of Solution

Transaction on December 31, 2019:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (4)		512
	Lease payable (Difference)		5,488
	Cash			6,000
	(To record annual lease payment and interest expenses.)
	Amortization expense (5)		5,488
	Right-of-use asset			5,488
	(To record amortization expense.)

Table (3)

Working note:

Calculate the amount of interest expense for December 31, 2019 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \text{Lease liability outstanding balance}\\ =5\text{\%}\times \left(\$16,428-\$6,179\right)\\ =\$512\end{array}$ (4)

Calculate the amortization expense for December 31, 2019 as follows:

$\begin{array}{c}\text{Amortization expenses = Annual lease payments}-\text{Interest expense}\\ =\$6,000-\$512\left(4\right)\\ =\$5,488\end{array}$ (5)

Transaction on December 31, 2019: Record lease payments and interest expense

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $512.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $5,488.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $6,000.

Transaction on December 31, 2019: Record amortization expense

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $5,488.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $5,488.

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.

(4)

To determine

To Prepare: appropriate entries for H Consulting (Lessee) to record the right-of-use asset and lease liability at December 31, 2020.

Explanation of Solution

Transaction on December 31, 2020:

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (6)		238
	Lease payable (Difference)		4,762
	Cash			5,000
	(To record annual lease payment and interest expenses.)
	Amortization expense (7)		5,762
	Right-of-use asset			5,762
	(To record amortization expense.)

Table (4)

Working note:

Calculate the amount of interest expense for December 31, 2020 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \text{Lease liability outstanding balance}\\ =5\text{\%}\times \left(\$16,428-\$6,179-\$5,488\right)\\ =\$238\end{array}$ (6)

Calculate the amortization expense for December 31, 2020 as follows:

$\begin{array}{c}\text{Amortization expenses = Annual lease payments}-\text{Interest expense}\\ =\$6,000-\$238\left(6\right)\\ =\$5,762\end{array}$ (7)

Transaction on December 31, 2020: Record lease payments and interest expense

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $238.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $4,762.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $5,000.

Transaction on December 31, 2020: Record amortization expense

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $5,762.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $5,762.

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.