Problem

Lessee Accounting with Payments Made at Beginning of Year

Adden Company signs a lease agreement dated January 1, 2016, that provides for it to lease heavy equipment from Scott Rental Company beginning January 1, 2016. The lease terms, provisions, and related events are as follows:

1. The lease term is 4 years. The lease is noncancelable and requires annual rental payments of $20,000 to be paid in advance at the beginning of each year.

2. The cost, and also fair value, of the heavy equipment to Scott at the inception of the lease is $68,036.62. The equipment has an estimated life of 4 years and has a zero estimated residual value at the end of this time.

3. Adden agrees to pay all executory costs.

4. The lease contains no renewal or bargain purchase option.

5. Scott's interest rate implicit in the lease is 12%. Adden is aware of this rate, which is equal to its borrowing rate.

6. Adden uses the straight-line method to record depreciation on similar equipment.

7. Executory costs paid at the end of the year by Adden are:

2016                                   2017
Insurance, $1,500             Insurance, $1,300
Property taxes, $6,000      Property taxes, $5,500

Required:

1. Next Level Examine and evaluate each capitalization criteria and determine what type of lease this is for Adden.

2. Prepare a table summarizing the lease payments and interest expense for Adden.

3. Prepare journal entries for Adden for the years 2016 and 2017.