(Accounting for an Operating Lease) On January 1, 2017, Doug Nelson Co. leased a building to Patrick Wise Inc. The relevant information related to the lease is as follows.

1. The lease arrangement is for 10 years.
2. The leased building cost \(4,500,000 and was purchased for cash on January 1, 2017.
3. The building is depreciated on a straight-line basis. Its estimated economic life is 50 years with no salvage value.
4. Lease payments are \)275,000 per year and are made at the end of the year.
5. Property tax expense of \(85,000 and insurance expense of \)10,000 on the building were incurred by Nelson in the first year. Payment on these two items was made at the end of the year.
6. 6. Both the lessor and the lessee are on a calendar-year basis.

Instructions

1. Prepare the journal entries that Nelson Co. should make in 2017.

Step by step solution

01

Meaning of Operating Lease

An operating lease is a contract that grants the right to utilize assets but not the right to own them. Leased assets and liabilities associated with leased assets are not recorded in the company's balance sheet; hence, operational leases are considered off-balance-sheet financing.

02

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
Jan. 1, 2017	Buildings	4,500,000
	Cash		4,500,000
Dec. 31, 2017	Cash	275,000
	Rent Revenue		275,000
Dec. 31, 2017	Depreciation Expense	90,000
	Accumulated Depreciation Buildings		90,000
Dec. 31, 2017	Property Tax Expense	85,000
	Insurance Expense	10,000
	Cash		95,000

Working Notes:

Calculation of accumulated depreciation

$$\begin{gathered} \mathrm{Accumulated}\mathrm{Depreciation}=\frac{\mathrm{Leased}\mathrm{building}\mathrm{cost}}{\mathrm{useful}\mathrm{life}} \\ =\frac{\$4,500,000}{50} \\ =\$90,000 \end{gathered}$$

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