Finance lease (also known as a capital lease) is a lease in which the lessee effectively acquires ownership of the leased asset, with the asset and liability recorded on the balance sheet. Below are examples of journal entries related to a finance lease, covering different stages of the lease.
Example 1: Initial Recognition of the Lease
Scenario:
On January 1, 2024, Company A enters into a finance lease for a piece of equipment. The present value of the lease payments is $100,000. The company agrees to make annual lease payments of $20,000 over five years.
Journal Entry (Initial Recognition):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-01-2024 | Right-of-Use Asset A/c Debit | 100,000 | |
| 01-01-2024 | To Lease Liability A/c | 100,000 |
Explanation:
- Right-of-Use Asset will debited to recognize the asset acquired through the finance lease.
- Lease Liability will credited to record the obligation to make future lease payments.
Example 2: First Lease Payment
Scenario:
On December 31, 2024, Company A makes the first annual lease payment of $20,000. The interest portion of the payment is $5,000, and the principal portion is $15,000.
Journal Entry (Lease Payment):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Interest Expense A/c Debit | 5,000 | |
| 12-31-2024 | Lease Liability A/c Debit | 15,000 | |
| 12-31-2024 | To Bank A/c | 20,000 |
Explanation:
- Interest Expense will debited to record the interest cost for the period.
- Lease Liability will debited to reduce the outstanding obligation.
- Bank will credited to reflect the payment made.
Example 3: Depreciation of the Right-of-Use Asset
Scenario:
Company A depreciates the right-of-use asset over the five-year lease term on a straight-line basis. The annual depreciation is $20,000.
Journal Entry (Depreciation):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Depreciation Expense A/c Debit | 20,000 | |
| 12-31-2024 | To Accumulated Depreciation A/c | 20,000 |
Explanation:
- Depreciation Expense will debited to record the cost of using the asset.
- Accumulated Depreciation will credited to reduce the carrying value of the asset over time.
Example 4: Subsequent Lease Payments
Scenario:
On December 31, 2025, Company A makes the second annual lease payment. The interest portion is now $4,000, and the principal portion is $16,000.
Journal Entry (Lease Payment):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2025 | Interest Expense A/c Debit | 4,000 | |
| 12-31-2025 | Lease Liability A/c Debit | 16,000 | |
| 12-31-2025 | To Bank A/c | 20,000 |
Explanation:
- Interest Expense will debited to record the interest cost for the second year.
- Lease Liability will debited to further reduce the outstanding lease obligation.
- Bank will credited to reflect the payment made.
Example 5: End of Lease Term
Scenario:
At the end of the five-year lease term, the lease liability and right-of-use asset will be fully amortized.
Journal Entry (Final Payment):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2028 | Interest Expense A/c Debit | 1,000 | |
| 12-31-2028 | Lease Liability A/c Debit | 19,000 | |
| 12-31-2028 | To Bank A/c | 20,000 |
Explanation:
- Interest Expense will debited for the final interest charge.
- Lease Liability will debited to eliminate the remaining liability.
- Bank will credited to record the final lease payment.
These examples demonstrate how finance lease transactions are recorded in the accounting records, ensuring that both the asset and liability are properly reflected on the balance sheet, and expenses are recognized over the life of the lease.