Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $25,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $180,000 (its fair value) and was expected to have a useful life of 12 years with no salvage value at the end of its life. (Because the lease term is only nine years, the asset does have an expected residual value at the end of the lease term of $50,995.) Crescent seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
  
Required:
1. What will be the effect of the lease on Café Med’s earnings for the first year? (ignore taxes) (Enter decreases with negative sign.)
2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Café Med? (ignore taxes)
(For all requirements, round your intermediate calculations and final answers to the nearest whole dollars.)

1. Effect on earnings 2.Lease payable balance (end of year) Right-of-use asset balance (end of year)

Please help!

Answer 1

Value given
Annual Lease Rentals = $ 25,000
Rate of Interest = 10%
Lease Period = 9 years
Computation of Present Value of Lease Rentals
= P * (1-(1-r) ^-n)/r
where, P = Annual Lease Rent
r = rate of interest
n = period
Annual Lease Rental(P)			$25,000
Rate of interest (r.)			10%
Period (n)			9
PV = P*(1-(1+r) ^-n)/r)			$143,976
The Lease Asset & Lease Liability would be booked at the present value
of the Annual Lease Rental = $ 143,976
Depreciation = Asset Value/ Lease Period
= $ 143,976/9
= $ 15,997
Schedule of Lease Amortization
Year	Beginning Balance	Lease Rental	Interest Expense	Principle Payment	Ending Balance
1	$143,976	$25,000	$14,398	$10,602	$133,374
2	$133,374	$25,000	$13,337	$11,663	$121,711
3	$121,711	$25,000	$12,171	$12,829	$108,882
4	$108,882	$25,000	$10,888	$14,112	$94,770
5	$94,770	$25,000	$9,477	$15,523	$79,247
6	$79,247	$25,000	$7,925	$17,075	$62,172
7	$62,172	$25,000	$6,217	$18,783	$43,389
8	$43,389	$25,000	$4,339	$20,661	$22,728
9	$22,728	$25,000	$2,273	$22,728	$0
Interest on Lease Liability in Year 1 = $ 14,398
1. Effect on Earnings
Due to the above mentioned lease agreement with Crescent Corporation,
Café' Med will incurr the following additional expenses
Depreciation Expense			$15,997
Interest Expense			$14,398
Total Expense			$30,395
Due to increase in expenses, the total earnings will decrease by $ 30,395
Answer
Effect on earnings		-$30,395
2.
Café' Med will have the following two balance sheet items due to the lease
agreement
(a) Lease Asset - Machinery(Right to use asset)
(b) Lease Liability Account(Lease Payable)
At the end of the first year, the balances in the two accounts would be as
under:
Right of use asset
Lease Asset Value				$143,976
Less: Depreciation for Year 1				$15,997
Right of use asset(end of the year)				$127,979
Lease payable balance
Opening Lease Liability				$143,976
Less: Lease Principle paid in Year 1				$10,602
Lease payable balance(end of the year)				$133,374
Answer
Lease payable balance(end of the year)				$133,374
Right of use asset(end of the year)				$127,979