Each of the independent situations below describes a capital lease in which annu

Question

Each of the independent situations below describes a capital lease in which annual lease payments are payable at the beginning of each year. The lessee is aware of the lessor's implicit interest rate.

Situation

1

2

Lease term

10 yrs

20 yrs

Lessor's desired

  rate of return

10%

12%

Lessee's incremental

  borrowing rate

12%

10%

Fair value of asset

$600,000

$400,000

For convenience, here are some table values:

Periods; int. rate

PV, ordinary annuity

PV, annuity due

10 periods, 10%

6.1446

6.7590

10 periods, 12%

5.6502

6.3283

20 periods, 10%

8.5136

9.3649

20 periods, 12%

7.4694

8.3658

Required:

For each situation determine the amount recorded as a liability by the lessee at the inception of the lease.

Situation

1

2

Lease term

10 yrs

20 yrs

Lessor's desired

  rate of return

10%

12%

Lessee's incremental

  borrowing rate

12%

10%

Fair value of asset

$600,000

$400,000

Explanation / Answer

The liablity will be recognised by using the lower of fair value of the assets or the parsent value of minimum Lease payments Parsent value of Minimum Lease Payments is decided by applying the Lower of Rate of Return of Lessor ( if Known by lesse) or Lesse's incremental Borrowing rate wiith the Annua Lease payment. In the Parsent Case #Since lease payments are payable at the beginning of each year we well take PV Annuity Due ##Since Minimum lease Payment amount is not given so we will assume as equall of fair value in Lese Term Situation 1 2 A Lease term 10 yrs 20 yrs B Lessor's desired  rate of return 10% 12% C Lessee's incremental borrowing rate 12% 10% D Rate of PV ( Lower of B or C) 10% 10% E PV Annuity Due # 6.7590 9.3649 F Fair value of asset $600,000 $400,000 G ## Minimum Lease Payment per year ($) (F/A) 60000 20000 H PV of Minimum Lease Payment (E X   G)   ($)          405,540         187,298 I Lease Liability ( lower of F and H) ($) 405540         187,298

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