On January 1, 2019, Caswell Company signs a 10-year cancelable (at the option of either party) agreement to lease a storage building from Wake Company. The following information pertains to this lease agreement: 1. The agreement requires rental payments of $100,000 at the beginning of each year. 2. The cost and fair value of the building on January 1, 2019, is $2 million. The storage building has not been specialized for Caswell. 3. The building has an estimated economic life of 50 years, with no residual value. Caswell depreciates similar buildings according to the straight- line method. 4. The lease does not contain a renewable option clause. At the termination of the lease, the building reverts to the lessor. 5. Caswell's incremental borrowing rate is 14% per year. Wake set the annual rental to ensure a 16% rate of return (the loss in service value anticipated for the term of the lease). Caswell knows the implicit interest rate. 6. Executory costs of $7,000 annually, related to taxes on the property, are paid by Caswell directly to the taxing authority on Dec. 31 of each year. Required: 1. Determine what type of lease this is for the lessee. 2. Prepare appropriate journal entries on the lessee's books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease for the years 2019 and 2020. CHART OF ACCOUNTS Caswell Company General Ledger ASSETS REVENUE 111 Cash 411 Sales Revenue 121 Accounts Receivable 141 Inventory EXPENSES 152 Prepaid Insurance 500 Cost of Goods Sold 190 Right-of-Use Asset 511 Insurance Expense 512 Utilities Expense LIABILITIES 513 Rent Expense 211 Accounts Payable 514 Lease Expense 231 Salaries Payable 521 Salaries Expense 253 Lease Liability 532 Bad Debt Expense 261 Income Taxes Payable 540 Interest Expense 541 Depreciation Expense EQUITY 559 Miscellaneous Expenses 311 Common Stock 910 Tax Expense 331 Retained Earnings Determine what type of lease this is for the lessee. Classification Criteria Met Transfer of ownership at end of lease No Bargain purchase option Lease term is for a major part of economic life Present value of lease payments and any guaranteed residual value equals or exceeds substantially all of the fair value Specialized nature of the asset Determine what type of lease this is for Caswell. Finance lease Operating lease 2. Prepare appropriate journal entries on the lessee's books to reflect the signing of the lease agreement and to record the payments and expenses related to this lease on Decemb 31 for the years 2019 and 2020. General Journal Instructions PAGE 2019 GENERAL JOURNAL DATE ACCOUNT TITLE POST. REF. DEBIT CREDIT 1 2 3 4 5 6 7 9 Record the payments and expenses related to this lease on December 31 for 2020. PAGE 2020 GENERAL JOURNAL DATE ACCOUNT TITLE POST. REF. DEBIT CREDIT 1 2 3 4 5 6 7
