Question

Werner Chemical, Inc., leased a protein analyzer on September 30, 2018. The five-year lease agreement calls for Werner to make quarterly lease payments of $398,076, payable each September 30, December 31, March 31, June 30, with the first payment at September 30, 2018. Werner's incremental borrowing rate is 8%. Amortization is recorded on a straightline basis at the end of each fiscal year. The useful life of the equipment is five years. (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. Determine the present value of the lease payments at September 30, 2018. 2. What pretax amounts related to the lease would Werner report in its balance sheet at December 31, 2018? 3. What pretax amounts related to the lease would Werner report in its income statement for the year ended December 31, 2018? 4. What pretax amounts related to the lease would Werner report in its statement of cash flows for the year ended December 31, 2018?

Answer 1

1)Quarterly interest rate = 8/4 =2%   per quarter

Number of quarters=5 years *4 = 20

Present value of lease payment = PVAD2%,20*Quarterly lease payment

                          = 16.67846 * 398076

                          = $ 6,639,294.64   (rounded to 6,639,295 )

2)Lease amortization schedule :

	A	B	C	D
Period	Installment paid	Interest expense [D*.02]	Principal repayment [A-B]	Balance at end [D of last quarter-C]
Sep 30 2018				6639295
Sep 30 2018	398076	0	398076	6639295-398076= 6241219
December 31 2018	398076	6241219*.02=124824.38	398076-124824.38= 273251.62	6241219-273251.62= 5967967.38
Total	796152	124824.38	671327.62

amortization of lease asset = cost of right of use asset /number of quarters

                                          = 6639295 /10 = $ 663929.5 per quarter

Total amortization for 2018( 1Oct- 31Dec= 3 months or 1 quarter)= 663929.5

2)Amount to be reported in Balance sheet as on December 31 2018 :

Lease payable = 5,967,967.38

Right of use asset = 6639295 -663929.5 amortization = 5975365.5

3)Balance to report in income statement in income statement :

Interest expense = $ -124824.38   (since expense it will be subtracted from revenue)

4)

Amount to be reported in cash flow statement :

cash flow from operating activity = - 124824.38   (interest expense payment is a cash outflow)

Cash flow from financing activity = - 671327.62      (principal repayment is a part of financing activity)

Total cash outflow = - 796152