Question

On January 1, 2018, Majestic Mantles leased a lathe from Equipment Leasing under a finance lease. Lease payments are made annually. Title does not transfer to the lessee and there is no purchase option or guarantee of a residual value by Majestic. Portions of the Equipment Leasing’s lease amortization schedule appear below:

Effective Decrease in Outstanding Balance Jan. 1 Payments Interest Balance 257,535 230,035 225,538 220,592 215,152 209,167 202,583 2018 27,500 2018 27,500 27,500 27,500 27,500 27,500 27,500 27,500 2019 23,004 22,554 22,059 21,515 20,917 20,258 4,497 2020 4,946 5,441 5,985 6,583 2021 2022 2023 2024 7,242 195,342 20,661 22,727 24,998 2035 27,500 27,500 27,500 6,839 4,773 47,726 24,998 2036 2037 2,500 0 Required: 1. What is Majestic's lease liability at the beginning of the lease (after the first payment)? 2. What amount would Majestic record as a right-of-use asset? 3. What is the lease term in years? 4. What is the effective annual interest rate? (Round your percentage answers to 1 decimal place.) 5. What is the total amount of lease payments? 6. What is the total effective interest expense recorded over the term of the lease? Lease liability 1 2. Right-of-use asset 3 Lease term years 4. Effective annual interest rate Total of lease payments 5. Total effective interest expense 6.

Answer 1

Answers

1. Lease Liability = $230,035 (note 1)

2. Right of use asset is nothing but the beginning outstanding balance which is turn is nothing but the present value of lease payment = $257,535

3. Lease Term is from 2018 to 2037 = 20 years

4. Effective annual interest rate = 23004/230035 = 10.0% (note 2)

5. Total of lease payments = $27,500*20 (years) = $550,000

6. Total effective Interest Expense = Total of lease payments - beginning outstanding balance or present value of lease payments = $550,000 - $257,535 = $292,465

Explanation

1. Lease liability is calculated by deducting the First Payment made from the Beginning Outstanding Balance

2. Effective annual interest rate is calculated as Interest Paid/Beginning outstanding balance

As per the question: $257,535-$27,500 = $230,035