On January 2, 2016, Nori Mining Co. (lessee) entered into a 5-year lease for dri

Question

On January 2, 2016, Nori Mining Co. (lessee) entered into a 5-year lease for drilling equipment. Nori accounted for the acquisition as a capital lease for $240,000, which includes a $10,000 bargain purchase option. At the end of the lease, Nori expects to exercise the bargain purchase option. Nori estimates that the equipment’s fair value will be $20,000 at the end of its 8-year life. Nori regularly uses straight-line depreciation on similar equipment. For the year ended December 31, 2016, what amount should Nori recognize as depreciation expense on the leased asset?

Options are as follows:

$27,500

$30,000

$48,000

$46,000

Explanation / Answer

Bargain Purchase Option allows the lessee to purchase the property at the end of the lease term at below the expected fair value. In the given question, Nori expects to exercise the bargain purchase option.

The formula for calculating the depreciation as per the straight line method = (Cost- Residual Value)/ Useful Life.

It is to be noted that for calculating the annual depreciation, the total economic life of the asset must be used.

Further, the residual value of an asset is estimated at the fair value of the asset at the end of its useful life.

Now, In the given question,

The cost of acquistion of the capital lease = $ 240,000

The total economic life of the asset = 8 years

Fair Value = $ 20,000

Hence, Annual Depreciation using the formula stated above=

= $ (240,000-20,000)/8

= $ 27,500

Nori should therefore, recognize $ 27,500 as depreciation expense on the leased asset for the year ended December 31, 2016.

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.