On December 31, 2017, Day Company leased a new machine from Parr with the follow

Question

On December 31, 2017, Day Company leased a new machine from Parr with the following pertinent information:

5 years

$50,000

8 years

15%

11%

The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $375,500. Day early adopted ASU 2016-02.

1. Explain whether the lease will be an operating lease or a finance lease under ASU 2016-02

2. Compute the amount of Day's lease liability at the beginning of the lease term under ASU 2016-02 assuming that the first payment has been made.

Lease term

5 years

Annual rental payable on December 31 (beginning December 31, 2017)

$50,000

Useful life of machine

8 years

Day's incremental borrowing rate

15%

Implicit interest rate in lease (known by Day)

11%

Explanation / Answer

Day Company A lease is a capital lease if its term is 75% or more of the life of leased property.The rate to use to calculate present value is the lessor's implicit rate if known by the lessee and if it is lower than the lessee's incremental borrowing rate : Lease term 5 years = 62.5% and is a operating lease Life of machine = 8 years Lease payment x PV factor at 11%      = PV of lease 50000                    x 4.1024 = 205120

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