Question

Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Ray’s incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipment’s production, Ray warrants equipment for eight full years anyway. The lessor and the lessee use ASC 840 guidance for lease accounting.

Ford uses which one of the following interest rates to record this lease?

Multiple Choice

• Use 8.5% because it is the lesser of the implicit rate and Ray’s incremental borrowing rate.

• Use 9.0% because it is the lesser of the implicit rate and Ford’s incremental borrowing rate.

• Use 9.0% because it is the lessee’s incremental borrowing rate.

• Use 10.0% because it is the implicit lease rate of return to the lessor.

Answer 1

Multiple Choice
Use 8.5% because it is the lesser of the implicit rate and Ray’s incremental borrowing rate.
Use 9.0% because it is the lesser of the implicit rate and Ford’s incremental borrowing rate.	Correct
Use 9.0% because it is the lessee’s incremental borrowing rate.
Use 10.0% because it is the implicit lease rate of return to the lessor.
The minimum lease payments is  discounted using the lessee’s incremental borrowing rate if the lessee knows the implicit rate used by the lessor and the rate is less than the lessee’s rate, the lessee should use the lessor’s rate to discount the minimum lease payment . so,  lesser of the implicit rate and  incremental borrowing rate will be discount rate

Answer 2

The second one is correct.