Federated Fabrications leased a tooling machine on January 1, 2021, for a three-year period ending December 31, 2023. The lease agreement specified annual payments of $48,000 beginning with the first payment at the beginning of the lease, and each December 31 through 2022. The company had the option to purchase the machine on December 30, 2023, for $57,000 when its fair value was expected to be $72,000, a sufficient difference that exercise seems reasonably certain. The machine's estimated useful life was six years with no salvage value. Federated was aware that the lessor’s implicit rate of return was 10%.

Required:
a. Calculate the amount Federated should record as a right-of-use asset and lease liability for this finance lease.
b. Prepare an amortization schedule that describes the pattern of interest expense for Federated over the lease term.
c. Prepare the appropriate entries for Federated from the beginning of the lease through the end of the lease term.

we can calculate the right of use asset and lease liability by determining the present value of all future cash flows and after calculating present values sum them up

Requirement 1: Right of use asset and lease liability

Present value (year 0) = 48,000 / (1+10%)^0 = 48,000

Present value (year 1) = 48,000 x 1/(1+10%)^1

Present value (year 1) = 48,000 x 0.909 = 43,636

Present value (year 2) = 48,000 x 1/(1+10%)^2

Present value (year 2) = 48,000 x 0.826 = 39,670

Present value (year 3) = 57,000 x 1/(1+10%)^3

Present value (year 3) = 57,000 x 0.751 = 42,825

Total present value = 48,000 + 43,636 + 39,670 + 42,825

Total present value = 174,131

Right of use asset and lease liability = 174,131

Requirement 2: Amortization schedule

Date payments effective interest Decrease Outstanding

10% in balance balance

1/1/21 174,131

1/1/21 48,000 48,000 126,131

12/31/21 48,000 12,613 35,387 90,744

12/31/22 48,000 9.074 38,926 51,818

12/31/23 48,000 5,182 51,818

Requirement 3: Journal entries

Amortization expense = 174,131/6

Amortization expense = 29,022

1/1/21

Dr Righ of use 74,131

Cr Lease payable 74,131

1/1/21

Dr lease payable 48,000

Cr cash 48,000

12/31/21

Dr Lease payable 35,387

Dr Interest expense 12,613

Cr Cash 48,000

12/31/21

Dr Amortization expense 29,022

Cr Right of use 29,022

12/31/22

Dr Lease payable 38,926

Dr Interest expense 9,074

Cr Cash 48,000

12/31/22

Dr Amortization expense 29,022

Cr Right of use 29,022

12/31/23

Dr Lease payable 51,818

Dr Interest expense 5,182

Cr Cash 57,000

12/31/23

Dr Amortization expense 29,022

Cr Right of use 29,022