PROBLEM 21.

Ludwick Steel SA, as lessee, signed a lease agreement for equipment for 5
years, beginning December 31, 2019. Annual rental payments of €40,000 are to
be made at the beginning of each lease year (December 31). The interest rate
used by the lessor in setting the payment schedule is 6%; Ludwick's incremental
borrowing rate is 8%. Ludwick is unaware of the rate being used by the lessor.
At the end of the lease, Ludwick has the option to buy the equipment for
€5,000, considerably below its estimated fair value at that time. The equipment
has an estimated useful life of 7 years, with no residual value. Ludwick uses the
straight-line method of depreciation on similar owned equipment.
a. Prepare the journal entry or entries, with explanations, that Ludwick should
record on December 31, 2019.
b. Prepare the journal entry or entries, with explanations, that Ludwick should
record on December 31, 2020. (Prepare the lease amortization schedule for
all five payments.)
c. Prepare the journal entry or entries, with explanations, that Ludwick should
record on December 31, 2021.
d. What amounts would appear on Ludwick's December 31, 2021, statement of
financial position relative to the lease arrangement?

(a) December 31, 2019

Right-of-Use Asset............................................................. 175,888
Lease Liability............................................................
175,888*
(To record leased asset and related
liability at the present value of
5 future annual payments of €40,000
plus a bargain-purchase option of
€5,000 discounted at 8%)

*(€40,000 X 4.31213**) + (€5,000 X .68058***) = €175,888

**Present value of an annuity-due of 1 for 5 periods at 8%.
***Present value of 1 for 5 periods at 8%.

December 31, 2019

Lease Liability.................................................................... 40,000
Cash............................................................................
40,000
(To record the first rental payment)

(b) LUDWICK STEEL SA (Lessee)

Lease Amortization Schedule
(Annuity-Due Basis)

Annual Lease Reduction of

Payment Interest (8%) on Lease Liability Lease Liability
Date Liability
12/31/19 — — — €175,888
12/31/19 €40,000 € 0 €40,000 135,888
12/31/20 40,000 10,871 29,129 106,759
12/31/21 40,000 8,541 31,459 75,300
12/31/22 40,000 6,024 33,976 41,324
12/31/23 40,000 3,306 36,694 4,630
12/31/24 5,000 370 4,630 0

December 31, 2020

Depreciation Expense......................................................... 25,127
Right-of-Use Asset.....................................................
25,127
(To record amortization of the right-of-use asset based on a cost to
Ludwick of
€175,888 and a life of 7 years)

December 31, 2020

Interest Expense.................................................................. 10,871
Lease Liability.................................................................... 29,129
Cash............................................................................
40,000
(To record annual payment on lease
liability of which €10,871 represents
interest at 8% on the unpaid principal
 of €135,888)

(c) December 31, 2021

Depreciation Expense............................................................ 25,127
Right-of-Use Asset.........................................................
25,127
(To record annual amortization on leased
assets)

Interest Expense..................................................................... 8,541

Lease Liability....................................................................... 31,459
Cash................................................................................
40,000
(To record annual payment on lease
liability of which €8,541 represents
interest at 8% on the unpaid principal
of €106,759)

Note: When payment happens at the beginning of each year, at year end
need to accrue expense and liability without crediting cash.

PROBLEM 21.3 (Continued)

(d) LUDWICK STEEL SA

Statement of Financial Positon (Partial)
December 31, 2021

Non-current assets: Current liabilities:

Right-of-Use asset €125,634* Lease liability €33,976**

Long-term liabilities:
Lease liability €41,324***

*€175,888 – (€25,127 X 2)
**Reduction of lease liability in 2022 (see schedule in part (b)).
***Lease liability as of 12/31/21 less the reduction of lease liability in 2022
(€75,300 – €33,976)
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None