DU Journeys enters into an agreement with Traveler plc to lease a car on December 31, 2018. The following information relates to this agreement.
1. The term of the non-cancelable lease is 3 years with no renewal or bargain purchase option. The remaining economic life of the car is 3 years, and it is expected to have no residual value at the end of the lease term.
2. The fair value of the car was £15,000 at commencement of the lease.
3. Annual payments are required to be made on December 31 at the end of each year of the lease, beginning December 31, 2019. The first payment is to be of an amount of £5,552.82, with each payment increasing by a constant rate of 5% from the previous payment (i.e., the second payment will be £5,830.46 and the third and final payment will be £6,121.98).
4. DU Journeys' incremental borrowing rate is 8%. The rate implicit in the lease is unknown.
5. DU Journeys uses straight-line depreciation for all similar cars.
Instructions
a. Prepare DU Journeys' journal entries for 2018, 2019, and 2020.
b. Assume, instead of a constant rate of increase, the annual lease payments will increase according to a price index. At its current level, the price index stipulates that the first rental payment should be £5,820. What would be the impact on the journal entries made by DU Journeys at commencement of the lease, as well as for subsequent years?