Windsor Company leases an automobile with a fair value of $14,845 from John Simo

Question

Windsor Company leases an automobile with a fair value of $14,845 from John Simon Motors, Inc., on the following terms:

Windsor’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown.

QUESTIONS

1.What is the present value of the lease payments to determine the lease liability?

2.Based on the original fact pattern, record the lease on Windsor’s books at the date of commencement.

3.Record the second month’s lease payment.

4.Record the first month’s amortization on Windsor’s books (assume straight-line).

5.Suppose that instead of $1,030, Windsor expects the residual value to be only $500 (the guaranteed amount is still $1,030). How does the calculation of the present value of the lease payments change from part (b)?

PV of lease payments?

1. Non-cancelable term of 50 months. 2. Rental of $310 per month (at the beginning of each month). (The present value at 0.5% per month is $13,753.) 3. Windsor guarantees a residual value of $1,030 (the present value at 0.5% per month is $803). Windsor expects the probable residual value to be $1,030 at the end of the lease term. 4. Estimated economic life of the automobile is 60 months. 5.

Windsor’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown.

QUESTIONS

1.What is the present value of the lease payments to determine the lease liability?

2.Based on the original fact pattern, record the lease on Windsor’s books at the date of commencement.

3.Record the second month’s lease payment.

4.Record the first month’s amortization on Windsor’s books (assume straight-line).

5.Suppose that instead of $1,030, Windsor expects the residual value to be only $500 (the guaranteed amount is still $1,030). How does the calculation of the present value of the lease payments change from part (b)?

PV of lease payments?

Explanation / Answer

Ans-1- The minimum lease payments in the case of a guaranteed residual value by the lessee include the guaranteed residual value. The present value therefore is:

Monthly payment of $310 for 50 months $13,753

Residual value of $1,030 803

Present value of minimum lease payments $14,556

Ans-2 Recording the lease on Windsor's books at the date of commencement:

Account Titles Debit Credit

Leased Equipment 14,556

Lease Liability 14,556

Ans-3 The second month's lease payment

Lease liability 237

Interest expenses 73  

Cash 310

Ans-4- The first month's amortization on Windsor's books:

Depreciation Expenses 271

Accumulated Depreciation 271

3-Calculation of interest- $14,556*0.5%=$73

Lease liability=$310-73= $237

4-Calculation of Accumulated Depreciation-Capital Leases=[($14,556-1,030)/50months= $271

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