Question

Assume that on December 31, 2019, Kimberly-Clark Corp. signs a 10-year, non-cancelable lease agreement to lease a storage building from Sheffield Storage Company. The following information pertains to this lease agreement. 1. The agreement requires equal rental payments of $68,099 beginning on December 31, 2019. 2. The fair value of the building on December 31, 2019 is $498,137. 3. The building has an estimated economic life of 12 years, a guaranteed residual value of $10,000, and an expected residual value of $6,000. Kimberly-Clark depreciates similar buildings on the straight-line method. 4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor. 5. Kimberly-Clark’s incremental borrowing rate is 8% per year. The lessor’s implicit rate is not known by Kimberly-Clark.Required: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 2019, 2020, and 2021.

Answer 1

Answer:

the journal entry to record the signing of the lease agreement:

December 31, 2019, lease agreement signed

• Dr Right of use 493,506
•     Cr Lease liability 493,506

the lease liability must record the present value of the 10 annual lease payments: $68,099 and 8% discount rate:

present value of an annuity due = payment + {payment x [1 - (1 + r)⁻⁽ⁿ⁻¹⁾]/r}

• payment = 68,099
• r = 8%
• n - 1 = 10 - 1 = 9

PV annuity due = 68,099 + {68,099 x [1 - (1 + 0.08)⁹]/0.08} = 68,099 + 425,407 = $493,506

the journal entries to record the annual lease payments:

December 31, 2019, annual lease payment

• Dr Lease liability 68,099
•     Cr Cash 68,099

December 31, 2020, annual lease payment

• Dr Lease liability 34,066
• Dr Interest expense 34,033
•     Cr Cash 68,099

interest expense = ($493,506 - $68,099) x 8% = $34,033

December 31, 2020, depreciation expense

• Dr Depreciation expense - leased building 49,351
•     Cr Accumulated depreciation - leased building 49,351

December 31, 2021, annual lease payment

• Dr Lease liability 31,307
• Dr Interest expense 36,792
•     Cr Cash 68,099

interest expense = ($425,407 - $34,066) x 8% = $31,307

December 31, 2021, depreciation expense

• Dr Depreciation expense - leased building 49,351
•     Cr Accumulated depreciation - leased building 49,351