On January 1, 2014, Hayes, Inc. leases equipment from Smithsonian Company for an annual lease rental of $25,000.
term is five years, and the lessor's interest rate implicit in the lease is 8%. The lessee's incremental borrowing rate is 8
useful life of the equipment is five years, and its estimated residual value equals its removal cost. Annuity tables indic
present value of an annual lease rental of $1 (at 8% rate) is $3.993. The fair value of leased equipment equals the pres
rentals. (Assume the lease is capitalized.)
PART : 1 Prepare accounting entries required by Hayes, Inc. for 2014.
Date Particulars Debit ($) Credit ($)
1-Jan-14 Leased Equipment A/C 99825
($25000*3.993)
To Lease Liability A/C 99825
1-Jan-14 Lease Liability A/C 17014
Interest Expense A/C 7986
To Cash A/C 25000
1-Jan-14 Depreciation A/C 19965
($99825/5)
To Accumulated Depreciation A/C 19965
PART : 2 Compute and illustrate the effect on the income statement for the year ended December 31, 2014,
balance sheet as of December 31, 2014.
Effect on the Income Statement for the year ended December 31, 2014.
Particulars Amount ($)
Operating Income xxxxx
Less: Interest on Lease 7986
Less: Depreciation 19965
Income before tax xxxxx
Effect on the Balance sheet as on December 31, 2014.
Assets Amount ($) Liabilities Amount ($)
Current Assets: Current Liability 18375.12
Cash xxxx
Less: Lease Payment (25000) Non Current Liability 64435.88
Net Cash Balance xxxx
Non-Current Assets:
Lease Assets 99825
Depreciation (19965)
Net Lease Assets 79860
Note: The Cash balance and revenue is not provided in the question. So, that I am assuming "xxxx" as
the value.
PART 3&4 : Table showing payment of Interest and principal for the lease term:
Minimum
Interest @8% of
Period Opening Liability Lease
balance CV
Payment
1-Jan-14 $99,825.00
31-Dec.-2014 $99,825.00 $7,986.00 $25,000.00
31-Dec.-2015 $82,811.00 $6,624.88 $25,000.00
31-Dec.-2016 $64,435.88 $5,154.87 $25,000.00
31-Dec.-2017 $44,590.75 $3,567.26 $25,000.00
31-Dec.-2018 $23,158.01 $1,841.99 $25,000.00
Total Interest Expense= $25,175.00
PART: 5 Discuss the income and cash flow implications from this capital lease.
Lease payments are comprises of Principal and Interest. Here annual lease rental is of $25000 which broken dow
$17014 in principal and $ 7986 in interest. The "Principal" portion will go on Income statement as depreciation expen
interest portion goes on your income statement as interest expense. It get reduced by $25000. But depreciation is an o
expense, interest is not. So operating income is reduced by only $17014. Capital lease agreements can not be cancelle
include at least one of four criteria: A transfer of ownership to the lessee; a bargain purchase option; a lease term equi
percent or more of the asset’s expected economic life; or a present value of at least 90 percent of the asset’s fair value
lease expense payment will be recorded on the cash flow statement. A capital lease payment includes interest and prin
interest portion of the payment is included in the Cash Flows From Operating Activities section as a cash outflow. Th
portion of the payment is included in the Cash Flows From Financing Activities section as a cash outflow.
ease rental of $25,000. The lease
ntal borrowing rate is 8.25%. The
st. Annuity tables indicate that the
uipment equals the present value of
for 2014.
d December 31, 2014, and for the
1, 2014.
Plug for lease liability Lease liability Depreciation Annual Lease
amortization Carrying Value Expense Expense/Revenue
$17,014.00 $82,811.00 $19,965 $27,951.00
$18,375.12 $64,435.88 $19,965 $26,589.88
$19,845.13 $44,590.75 $19,965 $25,119.87
$21,432.74 $23,158.01 $19,965 $23,532.26
$23,158.01 $0.00 $19,965 $21,806.99
Total
Depreciation $99,825 $125,000.00
Expense
capital lease.
5000 which broken down into say
nt as depreciation expense. The
But depreciation is an operating
ents can not be cancelled and must
ption; a lease term equivalent to 75
of the asset’s fair value.the capital
ncludes interest and principal. The
n as a cash outflow. The principal
ash outflow.
