(Journal entries to record a capital lease transaction)

A town enters into a lease-purchase agreement with Trucks, Inc to acquire four garbage trucks. The agreement provides that the town pay $100,000 at the end of each year for four years.

Upon full payment, the trucks become town property. The agreement is based on an interest rate of 7%. (The present value of an annuity of $1 for 4 periods at 7% is 3.3872 .) The lease agreement is accounted for in the General Fund.

Required:
Prepare journal entries for the General Fund to record (a) the lease agreement and the lease payment (b) at the end of the first year and (c) at the end of the second year.

What will be an ideal response?

(a) Record lease agreement
Expenditures - capital outlay 338,720
Other financing sources - capital leases 338,720

(b) Lease payment at end of first year
Expenditures - capital lease principal 76,289
Expenditures - capital lease interest 23,711
Cash 100,000

(c) Lease payment at end of second year
Expenditures - capital lease principal 81,630
Expenditures - capital lease interest 18,370
Cash 100,000

Note - The present value of the lease is $100,000 x 3.3872 or $338,720 . Interest for the first year is $338,720 x .07 = $23,711; and payment on principal is the difference between the $100,000 cash payment and the interest of $23,711 . After the payment, the "outstanding debt" is the difference between the original debt of $338,720 and payment of $76,289, or $262,431 . Therefore, the second year's interest is $262,431 x .07= $18,370, and the payment on principal is $81,630 . (This problem could be varied by asking the student to prepare a schedule showing the principal and interest payments for the life of the lease.)