On December 31, Year One, Ace signs a lease to use a truck for four years. The t
ID: 2415422 • Letter: O
Question
On December 31, Year One, Ace signs a lease to use a truck for four years. The truck has a current value of $58,600. Four annual payments of $10,000 are to be paid with the first made on December 31, Year One. After that time, the truck (with an expected life of eight years) will be returned to the lessor. Ace has an incremental borrowing rate of 6 percent. The lessor has an implicit annual interest rate of 8 percent built into the contract. Ace is aware of this implicit rate. The present value of a four-year annuity due of $10,000 at a 6 percent annual rate is $36,700. The present value of a four-year annuity due of $10,000 at an 8 percent annual rate is $35,770. What liability should Ace report on its December 31, Year One, balance sheet?
a.$0
b.$10,000
c.$25,770
d.26,700
2.On January 1, Year One, the Lenoir Company leases equipment from Burke Corporation for eight years which is the entire life of the asset. It will be discarded at the end of that period. For Burke, this transaction is a direct financing leases using an implicit interest rate of 10 percent. Based on that rate, the annual payments are $12,000 beginning immediately. Lenoir is unaware of Burke's implicit but has an incremental borrowing rate of 8 percent. Assume that the present value of an ordinary annuity for eight years at an annual interest rate of 8 percent is 5.75 and at 10 percent is 5.33 whereas the present value of an annuity due for eight years at an annual interest rate of 8 percent is 6.21 and at 10 percent is 5.87. If the effective rate method is applied, what amount of interest expense should Lenoir report for Year Two? (Round to the nearest dollar.)
a.$4,089
b.$4,442
c.$4,516
d.$5,070
Explanation / Answer
1. The lessor of the truck will offer the lease payments calculated at his implicit rate of return. The has an implicit rate of 8% annual. The first lease payment will be made in Year 0 i.e. on the signing of lease, This will have a Present Value Factor of 1. Therefore, the present value of lease payments will be "present value of a four-year annuity due of $10,000 at an 8 percent annual rate minus present value of $10000 signing amount", which is equal to $35770 - $10000 = $25770.
Therefore the liability to be reported in Ace's Balance Sheet is $25770.
2. Present value of annuity due for 8 years @ 10% will be 5.87 [Year 1 = 1, Year 2 to 7 = 4.87] since the first lease payment will be made in the year 0 which has present value factor of 10.
$12000 is calculated by using the above implicit rate. Therefore the current value of the equipment is 12000 x 5.87 = $70440
Repayment Schedule for two years:
Year Outstanding in the Beg. Installment Interest @ 10% Principal Outstanding in the end 0 70440 12000 0 12000 58440 1 58440 12000 5844 6156 52284 2 52284 12000 5228 6772 45512Related Questions
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