Callaway Golf Co. leases telecommunication equipment. Assume the following data
ID: 2442492 • Letter: C
Question
Callaway Golf Co. leases telecommunication equipment. Assume the following data for equipment leased from Photon Company. The lease term is 5 years and requires equal rental payments of $31,000 at the beginning of each year. The equipment has a fair value at the inception of the lease of $138,000, an estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain purchase option. How should Callaway classify this lease?
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Explanation / Answer
Calculating the depreciation on the equipment over its useful life. Depreciation = (Cost of the asset - Salvage value) / useful life of the asset = ($138,000 - $0) / 8 = $17,250 Therefore, the annual depreciation expense is $17,250. The present value of the lease payment attributed to equipment is Annual payment $31,000 Present value of annuity factor 3.1699 (at 10% for 4yrs) Present value of annuity payments $98,267 But the payments are made at the beginning of each year where we have to find the annuity due value. Annuity due value = $98,267 + $31,000 = $129,267 Therefore, the present value of minimu lease payment is $129,267.The lease term is 75% less than the economic life of the equipment .The present value of the payment is more than 90% of the fair value of the asset. But there is no transfer of ownership which is not a capital lease because the transfer of ownership and bargain of purchase option takes place. Therefore, this is an operating lease. This lease option is not capitalized and it is accounted for as a rental expense.Related Questions
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