Question

Cullumber Company, a machinery dealer, leased a machine to Dexter Corporation on January 1, 2020. The lease is for an 8-year period and requires equal annual payments of $ 25,300 at the beginning of each year. The first payment is received on January 1, 2020. Cullumber had purchased the machine during 2019 for $ 170,000. Collectibility of lease payments by Cullumber is probable. Cullumber set the annual rental to ensure a 8% rate of return. The machine has an economic life of 10 years with no residual value and reverts to Cullumber at the termination of the lease. Assume that Dexter Corporation does not know the rate implicit in the lease used by Cullumber, and Dexter’s incremental borrowing rate is 10%. In addition, assume that Dexter incurs initial direct costs of $ 18,000.
A. Compute the amount of the lease liability and right-of-use asset for Dexter.
B.Prepare all necessary journal entries for Dexter for 2020. (record lease, Record first payment, record interest expense, record amortization of right of use asset)

Answer 1

Present value of annual lease payment = $148,471

Right-of-use asset = $166,471

Given:

Time for lease = 8 year

Annual payment = $25,300 at the beginning of each year

Cost of machine = $170,000

Rate of return = 8% (Annual)

Expected life of machine = 10 year

Incremental borrowing rate = 10%

Dexter incurs initial direct costs = $18,000

Computation:

Using excel formula for Present value of annual lease;

Present value of annual lease payment = Annual payment[PVAD(r,n)

Present value of annual lease payment = 25,300[PVAD (10%, 8 years)]

Present value of annual lease payment = $148,471

Right-of-use asset = Present value of annual lease payment + Dexter incurs initial direct costs

Right-of-use asset = $148,471 + $18,000

Right-of-use asset = $166,471

                              Books of (Dexter)

Date              Particular                        Debit        Credit

1/1/17   Right-of-use assets              166,471  

              Cash                                         18,000

              Lease liability                                 148,471  

1/1/17     Lease liability                       25,300  

              Cash                                          25,300  

31/12/17 Interest (148,471-25,300)x0.1  12,317  

               Interest Receivable                     12,317    

12/31/17 Depreciation (166,471/8) 20,809  

                Accumulated depreciation             20,809

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