E21-3B (Lessee Entries; Capital Lease with Executory Costs and Unguaranteed Residual Value) Assume that on January 1, 2014, Yard Waste Corp. signs a 6-year noncancelable lease agreement to lease an industrial-strength mulching machine. The following information pertains to this lease agreement.
1. The agreement requires equal rental payments of $81,680 beginning on January 1, 2014.
2. The fair value of the machine on January 1, 2014, is $400,000.
3. The machine has an estimated economic life of 10 years, with an unguaranteed residual value of $35,000. Yard Waste depreciates similar machines on the straight-line method.
4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor.
5. Yard Waste’s incremental borrowing rate is 8% per year. The lessor’s implicit rate is not known by Yard Waste.
6. The yearly rental payment includes $1,563.19 of executory costs related to insurance on the machine.
Instructions
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 2014 and 2015. Yard Waste’s corporate yearend
is December 31.