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I am quite confused with the accounting for lease payments made upfront. Please clarify on the following points:
1. First payment upfront directly reduces the capital part, no interest at this time. So the entry is Dr. Lease Liability and Cr. Cash
2. When the period ends, we incur an interest expense. What is the journal for that? Dr. Interest Expense and Cr. Interest Payable? Is is possible that we might credit Lease Liability instead of Interest Payable?
3. After the end of first period, what should be my liability balance?
4. At the beginning of next period, when we pay the lease payment, what is the journal entry?
1 yes
2 yes, you can credit the liability account, but beware, the liability on the balance sheet under long term and current liabilities is ONLY the capital element of the liability. The interest element is shown as an accrual in current liabilities
3 just answered this in answer to number 2
4 if you have credited the accrued interest to the liability account, double entry on payment is Dr liability and Cr cash
If you have credited the accrued interest to a separate ” interest payable ” account, double entry is Dr liability with the capital element of the instalment, Dr interest payable account with the accrued interest element of the instalment and Cr cash
Hope that clears up your confusion
Tutor, thanks a lot for the valuable inputs!! I’m almost through with the confusion. Just a small part left to be cleared out. Referring to your Answer no. 2, SFP should ONLY show the capital part of liability (both current and n/current). But the moment we credit the accrued interest to the liability account, the capital part is increased by that amount and the total is reflected accordingly in SFP. How can we show the sole capital part then? Please help.
You’re incorrect saying “the capital part is increased by that amount” – it isn’t. The amount you are showing in the liability account is increased, but the capital element is not increased. That’s why it may be better to credit the accrued interest to an “interest payable” account. Don’t credit the obligation account. That way you can see that the capital element outstanding remains unchanged by any adjustment for the accrued interest
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