as a machine with a fair market value of $100,000 that it leases for a $10,000 r
ID: 2580897 • Letter: A
Question
as a machine with a fair market value of $100,000 that it leases for a $10,000 residual value at the rth to the lessor when the asset is The L essor Company h ten-year period to Lessee machine Lease payments of $14,225 ar mmediately upon signing. The machine is expected to have a end of the lease term (although the lessee is not guaranteeing t is the amount that the used equipment is expected to be wo returned at the end of the le when calculating the present valu ompany. The machine has a remaining useful life of twelve years. e made at the beginning of each year and the first payment is due his amount). A "residual value" alues e of future lease payments (i.e, lessee accounting completely ase term. Lessees do not include any unguaranteed residual v Ignores any unguaranteed residual value) The lessor's implicit rate is 10% and the lessee's incremental borrowing rate is 12%. 1. Calculate the lease obligation that would be recorded by the lessee at the signing of this lease. 2. Calculate the interest expense reported by the lessee in the first year. Now change the facts a little bit. Assume that the lease contract requires the lessee to guarantee the residual value of $10,000. U.S. GAAP requires the lessee to include this guaranteed residual value when calculating the present value of future lease payments. Recalculate your answers to part 2 (lease obligation at signing) and part 3 (interest expense in the first year) under this new assumption that the Lessee guarantees this residual value. 3.Explanation / Answer
1. Lease obligation that would be recorded by Lessee.
a) Calculation of present value of minimum lease payment.
Minimum Lease payment
PV Factor
Present Value
$14,225
0.9091
$12,931.82
$14,225
0.8264
$11,756.20
$14,225
0.7513
$10,687.45
$14,225
0.6830
$9,715.87
$14,225
0.6209
$8,832.61
$14,225
0.5645
$8,029.64
$14,225
0.5132
$7,299.67
$14,225
0.4665
$6,636.07
$14,225
0.4241
$6,032.79
$14,225
0.3855
$5,484.35
$1,42,250
$87,406.47
Present value of minimum lease payment is less than fair value on inception of lease, hence liability should be recognized at $87,406.47
b) Statement showing apportionment of minimum lease payment
Year
Minimum Lease payment
Opening Receivable
Finance charges (interest)
Principal payment (Capital recovery)
Balance Receivable
1
$14,225
$87,406.47
$8,740.65
$5,484.35
$81,922.11
2
$14,225
$81,922.11
$8,192.21
$6,032.79
$75,889.33
3
$14,225
$75,889.33
$7,588.93
$6,636.07
$69,253.26
4
$14,225
$69,253.26
$6,925.33
$7,299.67
$61,953.58
5
$14,225
$61,953.58
$6,195.36
$8,029.64
$53,923.94
6
$14,225
$53,923.94
$5,392.39
$8,832.61
$45,091.34
7
$14,225
$45,091.34
$4,509.13
$9,715.87
$35,375.47
8
$14,225
$35,375.47
$3,537.55
$10,687.45
$24,688.02
9
$14,225
$24,688.02
$2,468.80
$11,756.20
$12,931.82
10
$14,225
$12,931.82
$1,293.18
$12,931.82
-$0.00
2. Interest expense reported by lessee.
Interest expense in first year is $8740.65
Year
Annual payment
Interest on liability
lease liability
Closing balance lease liability
87406.47
1
$14,225
$8,740.65
$5,484.35
$81,922.11
2
$14,225
$8,192.21
$6,032.79
$75,889.33
3
$14,225
$7,588.93
$6,636.07
$69,253.26
4
$14,225
$6,925.33
$7,299.67
$61,953.58
5
$14,225
$6,195.36
$8,029.64
$53,923.94
6
$14,225
$5,392.39
$8,832.61
$45,091.34
7
$14,225
$4,509.13
$9,715.87
$35,375.47
8
$14,225
$3,537.55
$10,687.45
$24,688.02
9
$14,225
$2,468.80
$11,756.20
$12,931.82
10
$14,225
$1,293.18
$12,931.82
-$0.00
3a. Calculation of present value of minimum lease payment with guarantee residual value of $10,000.
Minimum Lease payment
PV Factor
Present Value
$14,225
0.9091
$12,931.82
$14,225
0.8264
$11,756.20
$14,225
0.7513
$10,687.45
$14,225
0.6830
$9,715.87
$14,225
0.6209
$8,832.61
$14,225
0.5645
$8,029.64
$14,225
0.5132
$7,299.67
$14,225
0.4665
$6,636.07
$14,225
0.4241
$6,032.79
$24,225
0.3855
$9,339.79
$1,52,250
$91,261.90
Liability should be recognized at $91,261.90
3b. Interest expense reported by lessee, with guarantee residual value of $10,000
Year
Minimum Lease payment
Opening Receivable
Finance charges (interest)
Principal payment (Capital recovery)
Balance Receivable
1
$14,225
$91,261.90
$9,126.19
$5,098.81
$86,163.09
2
$14,225
$86,163.09
$8,616.31
$5,608.69
$80,554.40
3
$14,225
$80,554.40
$8,055.44
$6,169.56
$74,384.84
4
$14,225
$74,384.84
$7,438.48
$6,786.52
$67,598.32
5
$14,225
$67,598.32
$6,759.83
$7,465.17
$60,133.16
6
$14,225
$60,133.16
$6,013.32
$8,211.68
$51,921.47
7
$14,225
$51,921.47
$5,192.15
$9,032.85
$42,888.62
8
$14,225
$42,888.62
$4,288.86
$9,936.14
$32,952.48
9
$14,225
$32,952.48
$3,295.25
$10,929.75
$22,022.73
10
$24,225
$22,022.73
$2,202.27
$22,022.73
-$0.00
Minimum Lease payment
PV Factor
Present Value
$14,225
0.9091
$12,931.82
$14,225
0.8264
$11,756.20
$14,225
0.7513
$10,687.45
$14,225
0.6830
$9,715.87
$14,225
0.6209
$8,832.61
$14,225
0.5645
$8,029.64
$14,225
0.5132
$7,299.67
$14,225
0.4665
$6,636.07
$14,225
0.4241
$6,032.79
$14,225
0.3855
$5,484.35
$1,42,250
$87,406.47
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