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Likewise, at the end of the lease period, both the net book value of the lease asset and the balance of lease liability will become zero.IFinance is a pre-owned auto dealership with locations in Nesbit and Olive Branch TN. can make the journal entry for the lease payment in the first year with the interest expense of $3,194 and the lease liability reduction of $6,806 as below: Account Debit Credit Lease liability 6,806 Interest expense 3,194 Cash 10,000Īfter this journal entry, the balance of lease liability is $33,121 (39,927 – 6,806). Hence, the company can make the journal entry for the finance lease depreciation at the end of each year as below: Account Debit Credit Lease depreciation expense 7,985 Accumulated depreciation – lease 7,985Īfter this journal entry, the net book value of lease asset is $31,942 (39,927 – 7,985).Īs the lease term is 5 years and the interest rate is 8% per annum, the schedule of lease payments can be presented as in the table below: Year Lease payments Interest Lease liability reduction Lease liability balance Y0 39,927 Y1 10,000 3,194 6,806 33,121 Y2 10,000 2,650 7,350 25,771 Y3 10,000 2,062 7,938 17,833 Y4 10,000 1,427 8,573 9,259 Y5 10,000 741 9,259 0 Total 50,000 10,073 39,927 The finance lease deprecation in each year of the lease period can be calculated using the straight-line depreciation method with no salvage value as below: can make the finance lease journal entry with the debit of lease asset and the credit of lease liability as below: Account Debit Credit Lease asset 39,927 Lease liability 39,927

“n” represents the number of years (e.g.

“r” represents the annual interest (e.g.

*Discount factor can be calculated with the formula of “1/(1+r)^n” where:

Finance lease payment in the first year.

What is the journal entry of the finance lease for the different cases below? The lease calls for the annual payment of $10,000 each year for the 5 years period and the market interest rate is 8% per annum. The lease period is 5 years which is approximately the economic life of the leased equipment. enters a long-term lease agreement which is a finance lease for the use of equipment. Likewise, the company can make the journal entry for the finance lease payment as below: Account Debit Credit Lease liability 000 Interest expense 000 Cash 000 Exampleįor example, the company ABC Ltd. In this case, each payment that the company makes for the lease is similar to a mortgage payment which consists partly of interest expense and partly of repayment of debt. The lease liability is presented on the balance sheet, which is similar to the loan. Account Debit Credit Lease depreciation expense 000 Accumulated depreciation – lease 000 Finance lease payment Hence, the company needs to record depreciation expense in each period with the straight-line depreciation method. Likewise, the lease asset will need to be depreciated over the useful life of the lease period. The lease asset is presented on the balance sheet, which is similar to the fixed asset. In other words, it is the present value of whole lease payments in the lease contract. In this journal entry, the amount of lease asset or lease liability recorded is the fair value of total lease payments. Account Debit Credit Lease asset 000 Lease liability 000 The company can make the finance lease journal entry by debiting the lease asset account and crediting the lease liability account. Finance lease journal entry Initial recognition That is why the finance lease is considered much more complicated than the operating lease. Subsequently, the journal entry will also involve the deprecation of the lease asset as well the interest expense on the lease liability.

Likewise, the company needs to initially record the fair value of lease payments as a lease asset on one side and a lease liability on the other side.

Unlike an operating lease, a finance lease is more like a purchase on installment than a rental. In the journal entry of finance lease, the company needs to record the present value of total lease payments on the balance sheet. Finance lease is a type of long-term financing where the company enters the lease agreement to use the property or asset for a long period of time.