Star City leased a bulldozer for use in activities accounted for in the General Fund.The City paid $40,000 and agreed to pay $40,000 per year for 3 years.The bulldozer has a useful life of six years.The lease qualified as a capital lease.Assuming that the city maintains is books and records in a manner that facilitates the preparation of the government-wide financial statements, the appropriate entry at the date of acquisition would be
A)Debit Expenditures $160,000; Credit Cash $40,000 and Other financing sources $120,000.
B)Debit Expenditures $53,333 and Prepaid lease $106,667; Credit Cash $40,000 and Other financing sources $120,000.
C)Debit Equipment $160,000; Credit Cash $40,000 and Lease payable $120,000.
D)Debit Expenditures $160,000; Credit Cash $40,000 and Lease payable $120,000.

Question

Quizplus · Accepted Answer

The appropriate entry at the date of acquisition for a capital lease is to debit the asset being leased, which in this case is Equipment, for the present value of the lease payments, and credit Cash for the initial payment and Lease Payable for the remaining balance.
The present value of the lease payments is calculated as the present value of an ordinary annuity of $40,000 per year for 3 years, discounted at the city's incremental borrowing rate of interest. Using a 5% incremental borrowing rate, the present value of the lease payments is $106,651. Therefore, the entry would be:

Debit: Equipment $106,651 (present value of lease payments)
Debit: Expenditures $53,349 (to bring Equipment to full cost)
Credit: Cash $40,000
Credit: Lease Payable $120,000 ($40,000 per year for 3 years)

Therefore, the correct answer is C.

Star City Leased a Bulldozer for Use in Activities Accounted