Pr. 21-118Lessee accountingcapital lease.

Eubank Company, as lessee, enters into a lease agreement on July 1, 2014, for equipment. The following data are relevant to the lease agreement:

1.The term of the noncancelable lease is 4 years, with no renewal option. Payments of$782,757 are due on July 1 of each year.

2.The fair value of the equipment on July 1, 2014 is $2,800,000. The equipment has an economic life of 6 years with no salvage value.

3.Eubank depreciates similar machinery it owns on the sum-of-the-years-digits basis.

4.The lessee pays all executory costs.

5.Eubanks incremental borrowing rate is 10% per year. The lessee is aware that the lessor used an implicit rate of 8% in computing the lease payments (present value factor for 4periods at 8%, 3.57710; at 10%, 3.48685.

Instructions

(a)Indicate the type of lease Eubank Company has entered into and what accounting treatment is applicable.

(b)Prepare the journal entries on Eubanks books that relate to the lease agreement for the following dates: (Round all amounts to the nearest dollar. Include a partial amortization schedule.)1.July 1, 2014.2.December 31, 2014.3.July 1, 2015.4.December 31, 2015

Solution 21-118

(a) Capitalized amount:

$782,757 PV of an ordinary annuity for 4 periods at 8%

$782,757 3.57710 = $2,800,000

Because the present value of the lease payments ($2,800,000) equals the fair value,

$2,800,000, of the leased property, it is a capital lease and must be accounted for under the

capital lease method.

(b) 1. July 1, 2014

Leased Equipment....................................................................2,800,000

Lease Liability............................................................... 2,017,243

Cash 782,757

2. December 31, 2014

Depreciation Expense...............................................................560,000

Accumulated DepreciationCapital Leases

[($2,800,000 4/10) 6/12].....................................560,000

Interest Expense ($161,379 6/12).........................................80,690

Interest Payable............................................................80,690

Lease Amortization Schedule

Annual Interest on Reduction of Balance of

Date Lease Payment Unpaid Liability Lease Liability Lease Liability

7/1/14 $2,017,243

7/9/15 $782,757 $161,379 $621,378 1,395,865

7/9/16 782,757 111,669 671,088 724,777

3. July 1, 2015

Interest Expense........................................................................161,379

Lease Liability.............................................................................621,378

Cash.................................................................................782,757

(Interest payable entry assumed to have been reversed 1/1/15)

***Please explain how to get $161,379, 621378 and 111,669, 671088 and 6/12???