Question 2 (Lessee Entries with Residual Value)

The following facts pertain to a noncancelable lease agreement between Peanut Butter Stars and Peppermint Brittle, a lessee.

Inception date: January 1, 2012

Annual lease payment due at the beginning of each year,

Beginning with January 1, 2012 $124,798

Residual value of equipment at end of lease term,

guaranteed by the lessee $50,000

Lease term 6 years

Economic life of leased equipment 6 years

Fair Value of asset at January 1, 2012 $600,000

Lessors implicit rate 12%

Lessees incremental borrowing rate 12%

The lessee assumes responsibility for all executory costs, which are expected to amount to $5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straight-line depreciation method for all equipment.

a)Prepare an amortization schedule that would be suitable for the lessee for the lease term.

b)Prepare all of the journal entries for the lessee for 2012 and 2013 to record the lease agreement, the lease payments, and all expenses related to this lease. Assume the lessees annual accounting period ends on December 31.