Question

Shamrock Company leases an automobile with a fair value of $18,013 from John Simon Motors, Inc., on the following terms:

1.		Non-cancelable term of 50 months.
2.		Rental of $370 per month (at the beginning of each month). (The present value at 0.5% per month is $8,873.)
3.		Shamrock guarantees a residual value of $1,600 (the present value at 0.5% per month is $920). Delaney expects the probable residual value to be $1,600 at the end of the lease term.
4.		Estimated economic life of the automobile is 60 months.
5.		Shamrock’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown. Record the second month’s lease payment. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,275.) Record the first month’s amortization on Shamrock’s books (assume straight-line). (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 2 decimal places, e.g. 5,275.25.) Suppose that instead of $1,600, Shamrock expects the residual value to be only $500 (the guaranteed amount is still $1,600). How does the calculation of the present value of the lease payments change from part (b)? (Round answer to 0 decimal places, e.g. 5,275.)

Answer 1

A) Recording Second Month Journal Entry:

Lease liability A/c (Debit)   $ 326 ($370 - $44)

Interest Exp A/c (Debit) $ 44 ($8,873 * 0.5%)

Cash A/c (Credit) $ 370

B) Change in Present Value

Guaranteed Residual Value - $1,600

Probable amount to be paid at the end of the lease - $1,100 ($1,600 - $500)

The present value of the lease payments will be impacted by the probable amount to be paid. Hence Present value of $1,100 i.e $857 shall be added to the existing present value of the lease payments i.e. $8,873. The new present value of the lease payments will be $9,730.