Goal:

Intermediate 2 FSR Project Part #5: Leases

To practice recognizing and reporting leases. (See Topic Guides IFO 18, 20, 22, 23).

Information:

Paterson has traditionally purchased all of its manufacturing equipment. However, in 2022 they were unable to find a vendor willing to sell them a new $7,823,000 machine. After some careful negotiations, however, they were able to lease the needed equipment for 5 years. At the end of the lease Paterson will have the option to purchase the equipment for $626,000, the estimated fair value at the end of the lease. They currently plan to exercise the option and keep the equipment at the end of the lease, but that could change if they find a better option.

The machine has an estimated economic life of 7 years with no salvage value. The payments on the lease will be $1,518,698. Paterson does not know the implicit interest rate used by the vendor, but their incremental interest rate is 5.5%. The lease period began on May 1, 2022 and the first payment was made that day. Subsequent payments will be made each year and should be paid one day before the start date to ensure that no late penalties are accrued. In addition to the first payment, Paterson paid $18,000 in legal and other lease origination fees on May 1, 2022.

Paterson has decided to keep all of its accumulated depreciation in one account rather than create a separate account for leased assets.

Assignment:

1. Make the appropriate journal entries, if any, to account for the lease (including any necessary changes to income tax expense).