Question

On January 1, 2021, Wetick Optometrists leased diagnostic equipment from Southern Corp., which had purchased the equipment at a cost of $2,251,671. The lease agreement specifies six annual payments of $470,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2025. The six-year lease term ending December 31, 2026 (a year after the final payment), is equal to the estimated useful life of the equipment. The contract specifies that lease payments for each year will increase on the basis of the increase in the Consumer Price Index for the year just ended. Thus, the first payment will be $470,000, and the second and subsequent payments might be different. The CPI at the beginning of the lease is 120. Southern routinely acquires diagnostic equipment for lease to other firms. The interest rate in these financing arrangements is 10%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Prepare the appropriate journal entries for Wetick to record the lease at its beginning. 2. Assuming the CPI is 126 at that time, prepare the appropriate journal entries related to the lease for Wetick at December 31, 2021.

Answer 1

Answer:

Equipment 2,251,669.78 DEBIT

     Cash                  470,000.00 CREDIT

     Lease Liability  1,781,669.78 CREDIT

--to record the beginning of the lease--

Lease liability                      291,833.02 debit

interest expense                178,166.98   debit

loss on monetary position  23,500       debit

       Cash                                   493,500    credit

Explanation:

We solve for the present value of the six payment of 470,000 to know the lease liability

Present Value of Annuity  

$C \times \displaystyle \frac{1-(1+r)^{-time}}{rate} (1+rate)= PV$  

C 470,000

time 6

rate 0.1

$470000 \times \displaystyle \frac{1-(1+0.1)^{-6}}{0.1} (1 + 0.10) = PV$  

PV $2,251,669.7816  

We subtract the first payment of 470,000

Lease liability account: 1,781,669.78

Second payment journal entry:

interest calculations:

1,781,669.78 x 0.1 = 178,166.98

principal payment:

470,000 - 178,166.98 = 291,833.02

inflation' adjustment:

470,000 x 126/120 = 493,500

The difference will be a loss on monetary position by the difference:

493,500 - 470,000 = 23,500