The following facts pertain to a non-cancelable lease agreement between Lennox Leasing Company and Gill Company, a lessee.

Inception date: May 1, 2017

Annual lease payment due at the beginning of each year, beginning with May 1, 2017: \(18,829.49

Bargain-purchase option price at end of lease term: \)4,000.00

Lease term: 5 years

Economic life of leased equipment: 10 years

Lessor’s cost: \(65,000.00; fair value of asset at May 1, 2017, \)81,000.00

Lessor’s implicit rate: 10%; lessee’s incremental borrowing rate 10%

The lessee assumes responsibility for all executory costs.

Instructions

(Round all numbers to the nearest cent.)

(d) Prepare the 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 2017 and 2018. Gill’s annual accounting period ends on December 31. Reversing entries are used by Gill. Assume Gill uses straight-line depreciation.

Step by step solution

01

Meaning of Lease Agreement

A lease agreement is a lawful bilateral agreement between the lessor and the lessee in which the lessor transfers the rights to use the assets to the lessee for a certain time and amount.

02

Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
May 5, 2017	Leased Equipment	81,000.00
	Lease Liability		81,000.00
May 5, 2017	Lease Liability	18,829.49
	Cash		18,829.49
Dec. 31, 2017	Interest Expense	4,144.70
	Interest Payable		4,144.70
Dec. 31, 2017	Depreciation Expense	5,400
	Accumulated Depreciation Capital Leases		5,400
Jan. 1, 2018	Interest Payable	4,144.70
	Interest Expense		4,144.70
May 5, 2018	Interest Expense	6,217.05
	Lease Liability	12,612.44
	Cash		18,829.49
Dec. 31, 2018	Interest Expense	3,303.87
	Interest Payable		3,303.87
Dec. 31, 2018	Depreciation Expense	8,100.00
	Accumulated Depreciation Capital Leases		8,100.00

Working notes:

Calculation of Interest payable on Dec. 31, 2017

$\begin{array}{rcl}\text{Interest}\text{payable}& =& \text{Interest}\text{on}\text{liability}\times \text{Total}\text{month}\\ & =& \$6,217.05\times \frac{8}{12}\\ & =& \$4,4114.70\end{array}$

Calculation of Accumulated depreciation on Dec. 31, 2017

$\begin{array}{rcl}\text{Accumulated}\text{depreciation}& =& \frac{\text{Leased}\text{equipment}}{\text{Economic}\text{life}}\\ & =& \frac{\$81,000}{10}\\ & =& \$8,100\end{array}$

Calculation of Interest payable on Dec. 31, 2018

$\begin{array}{rcl}\text{Interest}\text{payable}& =& \text{Interest}\text{on}\text{liability}\times \text{Total}\text{month}\\ & =& \$4,955.81\times \frac{8}{12}\\ & =& \$3,303.87\end{array}$

Calculation of Accumulated depreciation on Dec. 31, 2018

$\begin{array}{rcl}\text{Accumulated}\text{depreciation}& =& \frac{\text{Leased}\text{equipment}}{\text{Economic}\text{life}}\\ & =& \frac{\$81,000}{10}\\ & =& \$8,100\end{array}$

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