On December 31, 2019, Kingbird Corporation signed a 5-year, non-cancelable lease for a machine. The terms of the lease called for Kingbird to make annual payments of $8,508 at the beginning of each year, starting December 31, 2019. The machine has an estimated useful life of 6 years and a $4,700 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Kingbird uses the straight-line method of depreciation for all of its plant assets. Kingbird incremental borrowing rate is 2%, and the lessor’s implicit rate is unknown. Compute the present value of the lease payments. Prepare all necessary journal entries for Kingbird for this lease through December 31, 2020.

1.This is a capital lease since the lease term (5 years) is greater than 75% of the economic life (6 years) of the leased asset. The lease term is 831/3% (5 ÷ 6) of the asset’s economic life

2.Present value of lease payments

Year Cash Flow PV Factor at 5% Discounted cash flow

1 8,508.00 1 8,508.00

2 8,508.00 0.952381 8,102.86

3 8,508.00 0.907029 7,717.01

4 8,508.00 0.863838 7,349.53

5 8,508.00 0.822702 6,999.55

Total 38,677

Minimum value of lease payments=$38677

3.Journal Entries

a. To record the lease

Account Title debit Credit

Leased Equipment 38677

Lease Liability 8677

b.To record first lease payment

Account Title debit Credit

Lease Liability 8508

Cash 8508

c. To record amortization of right-of-use asset

Account Title debit Credit

Depreciation Expense 7735

Accumulated Depreciation - Capital Leases 7735

* $38677 / 5= $7735

d. To record interest expense

Account Title debit Credit

Interest Expense 1508

Interest Payable 1508

Lease Liability 7000

Interest Payable 1508

cash 8508

* (38677-8508) x 0.05 = 1508