Question

Shipping R US (LESSEE) leased an ocean-liner freighter from Viking Ships (LESSOR). The lease is non-cancelable and requires beginning of the year (annuity due) payments of $1,121,410.85 for seven years. At the end of the lease term the ocean-liner freighter reverts back to Viking Ships. Shipping R US's incremental borrowing rate is 6%, but knows that Viking Ships used a 4% present value discount rate in determining the annual lease payments. The current fair value of the ocean-liner freightor is $5,000,000 and has an estimated useful life of 10 years. The lease does not requires Shipping R US to guarantee that the residual value of the ocean-liner freighter at the end of the lease. The lease also requires Shipping R US to pay all executor costs, such as insurance, maintenance and taxes, of the ocean-liner freighter. Shipping R US uses the straight-line depreciation method for all of its CAPEX (property and equipment) assets. 
 What is the amount of Shipping R US’s initial lease obligation to Viking Ships (round to nearest dollar)? +1 POINT
$1,429,843.99
 What is the annual amortization expense related to the right of use asset that Shipping R US would record on its regular income statement?

1. What is the annual amortization expense related to the right of use asset that Shipping R US would record on its regular income statement?
2. 1. Assume that the lease agreement required Shipping R US to guarantee the $300,000 residual value of the ocean-freighter at the end of the lease. Shipping R US expects that it is probable that the expected value of the ocean-liner will be greater than the $300,000 guaranteed residual value at the end of the lease.
   2. 1. What is Shipping R US’s initial lease obligation?
      2. 1. How much interest expense would Shipping R US recognize in its regular income statement at the end of the first year of the lease

Answer 1

Answer-1:

Shipping R US's Initial Lease Obligation to Viking Ships:

Year Annual Lease Payment DF @ 4% Discounted Lease payment 0 $ 1,121,410.85 1.00000 $ 1 1,121,410.85 0.96154 2 1,121,410.85 0.92456 3 1,121,410.85 0.88900 4 1,121,410.85 0.85480 5 1,121,410.85 0.82193 6 1,121,410.85 0.79031 Lease Obligation $ 1,121,410.85 1,078,279.66 1,036,807.37 996,930.16 958,586.69 921,717.98 886,267.28 7,000,000.00

Answer-2:

Annual Amortization Expenses:

Amortization Schedule Annual Annual Lease amortization Payment Expense Year Principal Lease obligation 1 $ 1,121,410.85 0 $ 2 1,121,410.85 $ 235,143.57 3 3 1,121,410.85 1.121 4 $ 199,692.87 1,121,410.85 $ 162,824.16 5 1,121,410.85 $ 124,480.69 6 1,121,410.85 $ 84,603.48 7 1,121,410.85 $ 43,131.19 Total $ 7,849,875.95 $ 849,875.95 $ $ 7,000,000.00 1,121,410.85 $ 5,878,589.15 886,267.28 $ 4,992,321.87 921,717.98 $ 4,070,603.89 958,586.69 $ 3,112,017.20 996,930.16 $ 2,115,087.03 1,036,807.37 $ 1,078,279.67 1,078,279.66 $ 0.00 7,000,000.00

Answer-3:

Shipping R US's Initial Lease Obligation to Viking Ships when there is guaranteed Residual Value of $300,000:

Year Annual Lease Payment DF @ 4% Discounted Lease payment 2 o $ 1,121,410.85 1.00000 $ 1,121,410.85 1 1,121,410.85 0.96154 1,078,279.66 1,121,410.85 0.92456 1,036,807.37 1,121,410.85 0.88900 996,930.16 1,121,410.85 0.85480 958,586.69 1,121,410.85 0.821931 921,717.98 1,121,410.85 0.79031 886,267.28 300,000.00 0.75992 227,975.34 Lease Obligation $ 7,227,975.34

Answer-4:

Annual Amortization Expenses when there is guaranteed Residual Value of $300,000:

Amortization Schedule Annual Annual Lease Lease Year amortization Principal Payment obligation Expense $ 7,227,975.34 1 $ 1,121,410.85 0 $ 1,121,410.85 $ 6,106,564.49 2 1,121,410.85 $ 244,262.58 877,148.27$ 5,229,416.22 3 1,121,410.85 $ 209,176.65 912,234.20 $ 4,317,182.02 4 1,121,410.85 $ 172,687.28 948,723.57 $ 3,368,458.45 5 1,121,410.85 $ 134,738.34 986,672.51 $ 2,381,785.94 6 1,121,410.85 $ 95,271.44 1,026,139.41 $ 1,355,646.53 7 1,121,410.85 $ 54,225.86 1,067,184.99 $ 288,461.54 7 3 00,000.00 $ 11,538.46 288,461.54$ (0.00) Total $ 8,149,875.95 $ 921,900.61 | $ 7,227,975.34