Question

Metcalf signs a three-year lease for an asset on January 1, 20x1, which calls for annual payments of $2,000 at the beginning of each year. The implicit rate is 10% and this rate is known by the lessee. The asset has a sales value of $8,000, a 5-year life and a residual value at zero at that time. The amount of ROU Asset amortization for the year ended December 31, 20x1 under GAAP is?

A. $1,824

B. $2,000

C. $1,653

D. $1,453

Answer 1

Answer: $ 1,824

Explanation:

In a lease, the lessee accounts for the lease liability and Right-of-Use(ROU) asset and then depreciates the assets on a straight-line basis unless some other systematic method of depreciating is not available.

For a Lessee, the amount for initial recognition can be calculated by discounting the lease payments to the present value using implicit rate of return, or in case the implicit rate cannot be ascertained, using the Incremental borrowing rate of Lessee.

Calculation of Present Value of Lease Payments:

Year	Lease Rental	Discounting Factor	Discounted Amount
1	2000	1	2,000
2	2000	0.9091	1,818
3	2000	0.8265	1,653
			5,471

Therefore the ROU asset will be initially recognized at $ 5,471. It will be depreciated over the lease term on a straight-line basis.

Therefore, depreciation per year = Value of ROU Asset / Lease term

= 5,471 / 3

= $ 1,824 (rounded to zero decimals)

Note: Calculation of discounting Factor,

The discounting factor can be calculated using the formulae

Discounting Factor = 1 / (1+r)n

where 'r' is the rate of discounting and 'n' is the year.

In this question, since the payments are made at the beginning of the year, we shall consider n as the previous year. ie For payments at the beginning of year 1, n=0 and for payments at the beginning of year 2, n =1 and so on.

Hence for Year 1,

Discounting Factor = 1 / (1.10)0

= 1

For Year 2,

Discounting Factor = 1 / (1.10)1

= 0.9091

For Year 3,

Discounting Factor = 1 / (1.10)2

= 0.8265