On January 1, 2011, Franklin Industries leased equipment on an eight-year term at $15,000 annual rental payments, paid in advance. There is a bargain purchase option on December 31, 2018 (end of lease), of $24,000. The economic life of the equipment is estimated to be 15 years. The interest rate is 12 percent.
(1) Give the necessary entries for 2011 assuming all payments after the initial payment are made on December 31.
(2) Give the entry at December 31, 2018, assuming the option is permitted to lapse and that there is no residual value because of obsolescence. Assume 2018 amortization entries have been made.

There's quite a lot to do here.

There's no indication of the fair value of the asset, so presumably it is being capitalised at the present value of the minimum lease payments.

The existence of the bargain purchase option is important because it means two things:

* the bargain purchase price is included in the calculation of the present value of the minimum lease payments in establishing the value the asset should be capitalised at; and

* it means that the asset is depreciated over the useful life of the asset rather than the term of the lease - it will be depreciated over 15 years, rather than the lease term of 8 years.


Before you can do anything else, you've got two calculations to do to:

* Calculate the present value of the minimum lease payments over 8 years, and;

* Calculate the present value of the bargain purchase option in 8 years - how much is $24,000 in 8 years time worth today.

Add them together and you've got the amount to be capitalised.

Then you need to put a lease schedule together showing the opening bal, cash paid, interest expense, principle payment to the lease and closing balance for the duration of the lease.

Once that's all done, you have everything you need to answer both parts of the question.