Question

PROBLEM: On January 1, 2019 Day Co. leased a new machine from Part with the following pertinent information: Lease term 6 years Annual rental payable at the beginning of each year $50,000 Useful life of machine 8 years Day's incremental borrowing rate 15% Implicit interest rate in lease (known by Day) 12% Present value of annuity of 1 in advance for 6 periods at 12% 4.61 15% 4.35 The lease passes ownership of the machine to Day at the termination of the lease. The cost of the machine on Parr's accounting record is $375,500. Hint: see bottom of pages 839 - 841 (chapter 15) of your text book for an illustrative example. Please write your answers in the space provided in each question. QUESTIONS: 1. At the beginning of the lease term, Day should record a lease liability of a. $375,500 b. $230,500 c. $217,500 d. $0

Answer 1

Answer-1:

Day should record lease liability of $230,500 (i.e. $50,000 * 4.61)

Answer-2:

Criteria to identify the type of lease:

(i) The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period

(ii) The life of the lease is 6 years and the economic life of the asset is 8 years. This is equal to 75%

(iii) Total PV = PV of minimum lease payment + PV of unguaranteed residual value

     = $230,500 + 0 = $230,500

   Asset's fair value is $375,500

      % of total PV to asset's fair value = $230,500 / $375,500 × 100 = 61.38% whch is lower than 90%

Conclusion: This is a capital lease because criteria (i) and(ii) are met.

Answer-3:

Machine	$    2,30,500
Lease liability		$       2,30,500

Answer-4:

Lease payable	$        50,000
Cash		$      50,000

Answer-5:

Lease payable	$        28,340
Interest expense	21,660
Cash		$      50,000

Answer-6:

Lease liability at the end of 2019 = $152,160