Question

please provide solution for these two questions

Caliper 1/-Leases aurent portion of longtem by 87. ABC leased a new machine from QRS on July 1, 20x19, under a lease with the following pertinent information: lease term 10 years annual rental payable at the beginning of each lease year $30,000 useful life of the machine 12 years implicit interest rate 14 percent present value of an annuity of S1 in advance for 10 periods at 14 percent 5.95 Present value of $1 for 10 periods at 14 percent 0.27 ABC has the option to purchase the machine at the end of the lease term, by paying $40,000, which approximates the expected fair value of the machine on the option exercise date. The cost of the machine on QRS's accounting records is $150,000. On July 1, 20x19, ABC should record a net capitalized leased asset of: A) $150,000 B) $178,500 C) $189,300 D) $190,000 Ans: B Difficulty: Medium Level of Learning: Application Topic: LO2 88. CDE leased equipment from HIJ on December 31, 20x11, for a 10-year period (also the useful life of the asset). Equal annual payments under the lease are $50,000 and are due on December 31 of each year. The first payment was made on December 31, 20x11, and the second payment was made on the next due date. The present value at December 31, 20x11, of the minimum lease payments over the lease term discounted at 10 percent (the implicit rate computed by HIJ and known by CDE) was $338,000. CDE's incremental borrowing rate was 12 percent at December 31, 20x11. The lease is appropriately accounted for as a finance lease by CDE. What should be the balance in CDE's liability under finance lease account at December 31, 20x12? A) $266,800 B) $272,560 C) $303,980 D) $400,000 Ans: A Difficulty: Medium Level of Learning: Application Topic: LO2 330000-50000 32 X10% = 28, 800 interest expens 28 BOD=2

Answer 1

Ans. 87 As per FASB and GAAP, a lease is classified as Capital lease if any of the following four conditions are met:

• The lessee automatically gains ownership of the asset at the end of the lease. – Here, in the question, this condition is not met since ABC has the option to buy but not obligation.
• The lessee can buy the asset at a bargain price at the end of the lease.- Here the lessee has the option to buy at fair market price.
• The lease runs for 75% or more of the asset's useful life. – The lease here runs for 10 out of 12 years (i.e.83.33%) of the useful life of asset.
• The present value of the lease payments is at least 90% of the asset's fair market value when the lease is created. – This is calculated as below.

Since the third condition is met from above, it is a capital lease. Under a capital lease, at the commencement of the lease, the lease is capitalized and recorded as an asset on the balance sheet at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease).

Present value of lease payments = Annual lease payment amount * PV of an annuity of $1 in advance for 10 periods at 14 percent

= $ 30,000 * 5.95 = $ 178,500

(Note: since lease payments are regular payments like an annuity and further payment is required at the beginning of each period, so PV factor for annuity due at given rate is used)

Further, unguaranteed residual value is give as $ 40,000, which is fair value of asset at the end of lease. Unguaranteed residual value means that it is not the financial obligation of the lessee. Here, ABC has the option and not the obligation to buy. The lessee does not recognize the unguaranteed residual value in the computation of minimum lease payments as well as the capitalization of leased asset under obligation.

So, fair value of asset at the initiation of lease = $ 178,500 + Unguaranteed residual value $0

So, asset will be capitalized for $ 178,500. Correct option is option B.

Ans. 88 Correct option is option A. Working as below:

Date	Time period	Lease outstanding balance at the beginning of the period	Interest Amount (10%)	Lease payment	Reduction in lease balance	Ending lease balance
December31,20x11	1	$338,000	Nil	$50,000	$50,000	$288,000
December31,20x12	2	$288,000	$28,800	$50,000	$21,200	$266,800

Working notes:

Present value of the lease,i.e., total lease amount at Dec. 31, 20x11 = $ 338,000

First payment of $ 50,000 is made on Dec. 31, 20x11 itself, so there is no interest payment involved and lease amount is reduced by principal $ 50,000 at Dec. 31, 20x11. Ending balance of lease on Dec. 31, 20x11 = $338,000 - $50,000 = $288,000

For 2nd payment at Dec. 31, 20x12, interest at 10% (lease implicit interest rate) will be charged on outstanding lease amount at the beginning of the period,i.e., $288,000.

Interest amount = $288,000 * 10% = $28,800

Principal portion paid off = $50,000 - $28,800

= $21,200

Therefore, balance lease amount at Dec. 31, 20x12 = $288,000 - $21,200 = $266,800.