Chapter B, Problem 6P

a. 1

To determine

Prepare journal entry to record the sale financed by the lease and the related cost of goods sold.

Explanation of Solution

Lease:

Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.

Capital lease:

Capital lease is a kind of lease wherein the capital assets are given for lease. In a capital lease, the ownership of the asset is retained by the lessee, and the lessee gains all the benefits of the assets, and accepts the ownership risks.

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Accounting rules for Journal entries:

• To record increase balance of account: Debit assets, expenses, losses and credit liabilities, capital, revenue and gains.
• To record decrease balance of account: Credit assets, expenses, losses and debit liabilities, capital, revenue and gains.

Prepare journal entry to record capital lease transactions in the lessor’s accounting records:

Date	Account titles and Explanation	Debit ($)	Credit ($)
November 1	Lease Payments Receivable	42,150
	Sales		42,150
	(Financed sale of truck to Company I using a Capital Lease. Lease calls for 36 monthly payments of $1,400 each, which included a 1 % monthly interest charge )

Table (1)

• Lease payments receivable is an asset and it is increased. Therefore, debit lease payments receivable account by $42,150.
• Sales are a component of stockholders and it is increased. Therefore, credit sales account by $42,150.

Date	Account titles and Explanation	Debit ($)	Credit ($)
November 1	Cost of goods sold	33,520
	Inventory		33,250
	(To record cost of truck sold under capital lease )

Table (2)

• Cost of goods sold is a component of stockholders’ equity and it is decreased. Therefore debit cost of goods sold account by $33,520.
• Inventory is an asset and it is decreased. Therefore, credit inventory account by $33,250.

a. 2

To determine

Prepare a compound journal entry that allocates the cash receipt between interest revenue and reduction of lease payments receivable.

Explanation of Solution

Compound journal entry:

A Journal entry having more than two accounts is known as compound journal entry. Any number of accounts can be recorded in a compound journal entry but the debit side must always equal the credit side.

Prepare compound journal entry:

Date	Account titles and Explanation	Debit ($)	Credit ($)
November 30	Cash	1,400
	Interest Revenue (1)		422
	Lease Payments Receivable (balancing figure) (2)		978
	(To record receipt of first monthly payment from Company I and to recognize finance charges earned in month)

Table (3)

• Cash is an asset and it is increased. Therefore, debit cash account by $1,400.
• Interest revenue is a component of stockholders’ equity and it is increased. Therefore, credit interest revenue account by $422.
• Lease payments receivable is an asset and it is decreased. Therefore, credit lease payment receivable account by $978.

Working note:

Calculate the amount of interest revenue:

$\begin{array}{c}\text{Interest}\text{revenue}\text{=}\left(\begin{array}{l}\text{Lease}\text{payments}\text{receivable}\\ \text{as}\text{on}\text{November1}\text{×}\text{Interest}\text{rate}\end{array}\right)\\ \text{=}\text{\$42,150}\text{×}\text{1\%}\\ \text{=\$422}\end{array}$

(1)

Calculate the lease payments receivable as on November 30 (first payment):

$\begin{array}{c}\begin{array}{l}\text{Lease}\text{payments}\text{receivable}\\ \text{as}\text{on}\text{November}\text{30}\end{array}\}\text{=}\text{Cash}-\text{Interest}\text{revenue}\\ \text{=}\text{\$1,400}-\text{\$422}\text{(1)}\\ \text{=\$978}\end{array}$

(2)

a. 3

To determine

Prepare journal entry to record the receipt of the second monthly payment.

Explanation of Solution

Prepare journal entry:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Cash	1,400
	Interest Revenue (3)		412
	Lease Payments Receivable (4)		988
	(To record receipt of second monthly payment from Company I and to recognize finance charges earned in month)

Table (4)

• Cash is an asset and it is increased. Therefore, debit cash account by $1,400.
• Interest revenue is a component of stockholders’ equity and it is increased. Therefore, credit interest revenue account by $412.
• Lease payments receivable is an asset and it is decreased. Therefore, credit lease payment receivable account by $988.

Working note:

Calculate the amount of interest revenue:

$\begin{array}{c}\text{Interest}\text{revenue}\text{=}\left(\begin{array}{l}\text{Lease}\text{payments}\text{receivable}\text{as}\text{on}\text{November1}-\\ \text{Lease}\text{payments}\text{receivable}\text{as}\text{on}\text{November30}\end{array}\right)\text{×}\text{Interest}\text{rate}\\ \text{=}\text{\$42,150}-\text{\$}\text{978}\text{×}\text{1\%}\\ \text{=\$412}\end{array}$

(3)

Calculate the lease payments receivable as on December 31 (second payment):

$\begin{array}{c}\begin{array}{l}\text{Lease}\text{payments}\text{receivable}\\ \text{as}\text{on}\text{December}\text{31}\end{array}\}\text{=}\text{Cash}-\text{Interest}\text{revenue}\\ \text{=}\text{\$1,400}-\text{\$412}\text{(3)}\\ \text{=\$988}\end{array}$

(4)

b. 1

To determine

Prepare journal entry to record acquisition of the leased truck

Explanation of Solution

Prepare journal entries to record capital transactions in lessee’s accounting records:

Date	Account titles and Explanation	Debit ($)	Credit ($)
November 1	Leased Equipment	42,150
	Lease payments obligation		42,150
	(To record acquisition of truck from custom truck builders on capital lease)

Table (5)

• Lease Equipment is an asset and it is increased. Therefore, debit lease equipment account by 42,150.
• Lease Payment Obligation is a liability and it is increased. Therefore, credit lease payment obligation account by $42,150.

b. 2

To determine

Prepare journal entry to record the first monthly lease payment.

Explanation of Solution

Prepare journal entry:

Date	Account titles and Explanation	Debit ($)	Credit ($)
November 30	Interest Expense (5)	422
	Lease payment obligation (6)	978
	Cash		1,400
	(To record first monthly payment to custom truck builders and to recognize one month’s interest charge on unpaid balance of lease payment obligation)

Table (6)

• Interest expense is a component of stockholders equity and it is decreased. Therefore, debit interest expense account by $422.
• Lease payment obligation is a liability and it is increased. Therefore, Credit lease payment obligation account by $978.
• Cash is an asset and it is decreased. Therefore, credit cash account by $1,400.

Working note:

Calculate the amount of interest expense:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left(\begin{array}{l}\text{Lease}\text{payments}\text{obligation}\\ \text{as}\text{on}\text{November1}\text{×}\text{Interest}\text{rate}\end{array}\right)\\ \text{=}\text{\$42,150}\text{×}\text{1\%}\\ \text{=\$422}\end{array}$

(5)

Calculate the lease payments obligation as on November 30:

$\begin{array}{c}\begin{array}{l}\text{Lease}\text{payments}\text{obligation}\\ \text{as}\text{on}\text{November}\text{30}\end{array}\}\text{=}\text{Cash}-\text{Interest}\text{expense}\\ \text{=}\text{\$1,400}-\text{\$422}\text{(5)}\\ \text{=\$978}\end{array}$

(6)

b. 3

To determine

Prepare journal entry to record the second monthly lease payment.

Explanation of Solution

Prepare journal entry:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Interest Expense (7)	412
	Lease payment obligation (8)	988
	Cash		1,400
	(To record second monthly payment to custom truck builders and to recognize one month’s interest charge on unpaid balance of lease payment obligation)

Table (7)

• Interest expense is a component of stockholders equity and it is decreased. Therefore, debit interest expense account by $412.
• Lease payment obligation is a liability and it is increased. Therefore, Credit lease payment obligation account by $988.
• Cash is an asset and it is decreased. Therefore, credit cash account by $1,400.

Working note:

Calculate the amount of interest expense:

$\begin{array}{c}\text{Interest}\text{expense}\text{=}\left(\begin{array}{l}\text{Lease}\text{payments}\text{obligation}\text{as}\text{on}\text{November1}-\\ \text{Lease}\text{payments}\text{obligation}\text{as}\text{on}\text{November30}\end{array}\right)\text{×}\text{Interest}\text{rate}\\ \text{=}\text{\$42,150}-\text{\$}\text{978}\text{(}\text{6)×}\text{1\%}\\ \text{=\$412}\end{array}$

(7)

Calculate the lease payments obligation as on December 31:

$\begin{array}{c}\begin{array}{l}\text{Lease}\text{payments}\text{obligation}\\ \text{as}\text{on}\text{December}\text{31}\end{array}\}\text{=}\text{Cash}-\text{Interest}\text{expense}\\ \text{=}\text{\$1,400}-\text{\$412}\text{(7)}\\ \text{=\$988}\end{array}$

(8)

b. 4

To determine

Prepare journal entry to recognize depreciation on the leased truck through year-end and Compute depreciation expense by the straight-line method.

Explanation of Solution

Depreciation expense:

Depreciation refers to allocation, of the cost for an asset to expense over the useful life of the asset. Depreciation expense relating to the current accounting period should be accounted for, by an adjusting entry.

Prepare journal entry:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Depreciation Expense-Leased Equipment (10)	600
	Accumulated Depreciation-Leased Equipment		600
	(To record two months’ depreciation on leased equipment)

Table (8)

• Depreciation expense is a component of stockholders’ equity and it is decreased. Therefore, debit depreciation expense account by $600.
• Accumulated depreciation is a contra asset and it is increased. Therefore, credit accumulated depreciation account by $600.

Working note:

Step 1:

Calculate the total depreciation expense of the truck:

$\begin{array}{c}\text{Depreciation}\text{expense}\text{=}\frac{\text{Sales}\text{price}\text{of}\text{truck}-\text{Salvage}\text{value}}{\text{Estimated}\text{service}\text{life}\text{of}\text{truck}}\\ \text{=}\frac{\text{\$42,150}-\text{\$6,150}}{\text{10}\text{years}\text{or}\text{120}\text{months}}\\ \text{=}\text{\$3,600}\end{array}$

(9)

Step 2:

Calculate the depreciation expense for 2 months (November 1 to December 31).

$\begin{array}{c}\begin{array}{l}\text{Depreciation}\text{expense}\\ \text{for}\text{2}\text{months}\end{array}\}\text{=}\text{Total}\text{depreciation}\text{expense}\text{×}\frac{\text{2}}{\text{12}}\\ \text{=}\text{\$3,600}\text{(9)×}\frac{\text{2}}{\text{12}}\\ \text{=}\text{\$600}\end{array}$

(10)

c.

To determine

Compute the net carrying value of the leased truck.

Explanation of Solution

Computation of net carrying value of leased equipment by Company I at December 31, 2018:

Particulars	Amount ($)
Leased equipment	42,150
Less: Accumulated depreciation- leased equipment (10)	600
Net carrying value, December 31, 2018	41,550

Table (9)

Therefore, from the above calculation it is noted that, the net carrying value is $41,550.

d.

To determine

Compute the amount of Company I’ lease payment obligation.

Explanation of Solution

Computation of lease payment obligation of Company I at December 31, 2018:

Particulars	Amount ($)	Amount ($)
Lease payment obligation, November 1, 2018		42,150
Less: Portions of monthly payments applied to principal:
November payment (6)	978
December payment (8)	988	1,966
Total		40,184

Table (10)

Therefore, from the above calculation it is noted that, the amount of Company I’ lease payment obligation is $40,184.