Chapter 15, Problem 15.17E

Lessee a nd lessor; operating lease

• LO15–4

On January 1, 2018, Nath-Langstrom Services, Inc. a computer software training firm, leased several computers under a two-year operating lease agreement from ComputerWorld Leasing, which routinely finances equipment for other firms at an annual interest rate of 4%. The contract calls for four rent payments of $10,000 each, payable semiannually on June 30 and December 31 each year. The computers were acquired by ComputerWorld at a cost of $90,000 and were expected to have a useful life of five years with no residual value. Both firms record amortization and depreciation semiannually.

Required:

Prepare the appropriate entries for both (a) the lessee and (b) the lessor from the beginning of the lease through the end of 2018.

To determine

Operating lease

This type of lease refers to the lease where the lessor permits the lessee to make use of the asset for a specified time period by charging rent without actual transfer of ownership of the asset which is leased. This type of lease cancellable and is of short term.

To prepare: appropriate entries for NLS Incorporation (Lessee) from the beginning of lease through end of 2018.

Explanation of Solution

Prepare journal entry for NLS Incorporation in the month of January 1, 2018

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Right-of-use asset (1)		38,077
		Lease Payable			38,077
		(To record the lease payable)

Table (1)

Explanation:

• Right-of-use asset is an asset. There is an increase in asset. Therefore, debit right-of-use asset account by $38,077.
• Lease payable is a liability. There is an increase in liability. Therefore, credit lease liability by $38,077.

Transaction on June 30, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (2)		762
	Lease payable (Difference)		9,238
	Cash			10,000
	(To record semi-annual lease payment and interest expenses.)

Table (2)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $762.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $9,238.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $10,000.

Transaction on June 30, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (3)		9,238
	Right-of-use asset			9,238
	(To record amortization expense.)

Table (3)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $9,238.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $9,238.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Transaction on December 31, 2018: Record the lease payments and interest expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Interest expenses (4)		577
	Lease payable (Difference)		9,423
	Cash			10,000
	(To record semi-annual lease payment and interest expenses.)

Table (4)

Explanation:

• Interest expense decreases stockholders’ equity. Therefore, debit interest expense by $577.
• Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $9,423.
• Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $10,000.

Transaction on December 31, 2018: Record the amortization expense.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
	Amortization expense (5)		9,423
	Right-of-use asset			9,423
	(To record amortization expense.)

Table (5)

Explanation:

• Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $9,423.
• Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $9,423.

In case of operating lease, the lessee would record interest expense and then “plug” the right-of-use asset amortization at the amount which is needed to make the total interest plus amortization amount equal to straight line lease payments made. A single lease expense would be recorded in the income statement of the lessee.

Working notes:

The number of years is taken as 4 periods $\left[2\text{years}\times 2\right]$ as interest is calculated semi-annually. The interest rate is calculated as 2% $\left[\frac{4\%}{2}\right]$ as interest is calculated for semi-annually.

Use the present value factor 3.80773 (Present value factor $1 for 4 periods at 2% rate) for calculating present value of lease payments.

Calculate the present value of lease payments as follows:

$\begin{array}{c}\begin{array}{l}\text{Present value }\\ \text{of lease payments}\end{array}\}\text{ =Semi-annual lease payments}\times \text{PVIFA}\left(2\%,4\right)\\ \text{=}\text{\$10,000}\times 3.80773\\ =\$38,077\end{array}$ (1)

Calculate the amount of interest expense for June 30, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \text{Lease liability initial balance}\\ =2\text{\%}\times \$38,077\\ =\$762\end{array}$ (2)

Calculate the amortization expense for June 30, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Semi-annual lease payments}-\text{Interest expense}\\ =\$10,000-\$762\left(2\right)\\ =\$9,238\end{array}$ (3)

Calculate the amount of interest expense for December 31, 2018 as follows:

$\begin{array}{c}\text{Interest expense}=\text{Rate of interest}\times \left(\begin{array}{l}\text{Lease liability initial balance}\\ -\text{Amortization expense, June 30}\end{array}\right)\\ =2\text{\%}\times \left(\$38,077-\$9,238\left(3\right)\right)\\ =\$577\end{array}$ (4)

Calculate the amortization expense for December 31, 2018 as follows:

$\begin{array}{c}\text{Amortization expenses = Semi-annual lease payments}-\text{Interest expense}\\ =\$15,000-\$577\left(4\right)\\ =\$9,423\end{array}$ (5)

To determine

To prepare: appropriate entries for CW leasing (Lessor) from the beginning of lease through end of 2018.

Explanation of Solution

Prepare journal entry for CW leasing in the month of January 1, 2018

No entry is needed

Transaction on June 30, 2018: Record the lease revenue.

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Cash		10,000
		Lease revenue			10,000
		(Record the lease revenue)

Table (6)

Explanation:

• Cash is an asset. There is an increase in asset. Therefore, credit cash account by $10,000.
• Lease revenue increases stockholders’ equity. Therefore, credit lease revenue by $10,000.

Transaction on June 30, 2018: Record the depreciation expense.

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Depreciation expense (5)		9,000
		Accumulated depreciation			9,000
		(Record the depreciation expense)

Table (7)

Explanation:

• Depreciation expenses decreases stockholders’ equity. Therefore, debit depreciation expense by $9,000.
• Accumulated depreciation is a contra asset and increases by $9,000. Therefore, credit accumulated depreciation by $9,000.

Transaction on December 31, 2018: Record the lease revenue.

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Cash		10,000
		Lease revenue			10,000
		(Record the lease revenue)

Table (8)

Explanation:

• Cash is an asset. There is an increase in asset. Therefore, credit cash account by $10,000.
• Lease revenue increases stockholders’ equity. Therefore, credit lease revenue by $10,000.

Transaction on December 31, 2018: Record the depreciation expense.

Date		Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
		Depreciation expense (6)		9,000
		Accumulated depreciation			9,000
		(Record the depreciation expense)

Table (9)

Explanation:

• Depreciation expenses decreases stockholders’ equity. Therefore, debit depreciation expense by $9,000.
• Accumulated depreciation is a contra asset and increases by $9,000. Therefore, credit accumulated depreciation by $9,000.

Working notes:

Calculate the depreciation expense for June 30, 2018 as follows:

$\begin{array}{c}\text{Depreciation expense = }\frac{\text{Cost of equipment}}{Totalperiods}\\ =\frac{\$90,000}{10\text{ Semi-annual periods}}\\ =\$9,000\end{array}$ (5)

Calculate the depreciation expense for December 31, 2018 as follows:

$\begin{array}{c}\text{Depreciation expense = }\frac{\text{Cost of equipment}}{Totalperiods}\\ =\frac{\$90,000}{10\text{Semi-annual periods}}\\ =\$9,000\end{array}$ (6)