Question

On June 30, 2021, Georgia-Atlantic, Inc. leased a warehouse equipment from IC Leasing Corporation. The lease agreement calls for Georgia-Atlantic to make semiannual lease payments of $530,203 over a four-year lease term, payable each June 30 and December 31, with the first payment at June 30, 2021. Georgia-Atlantic's incremental borrowing rate is 12%, the same rate IC uses to calculate lease payment amounts. Amortization is recorded on a straight-line basis at the end of each fiscal year. The fair value of the equipment is $3.5 million. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Determine the present value of the lease payments at June 30, 2021 that Georgia-Atlantic uses to record the right-of-use asset and lease liability. 2. What pretax amounts related to the lease would Georgia-Atlantic report in its balance sheet at December 31, 2021? 3. What pretax amounts related to the lease would Georgia-Atlantic report in its income statement for the year ended December 31, 2021? (For all requirements, enter your answers in whole dollars and not in millions. Round your final answers to the nearest whole dollar.)

1. Present value $3,489,998

2. Pretax amount for liability

3. Pretax amount for right-of-use asset

4. Pretax amount for interest expense

5. Pretax amount for amortization expense

Answer 1

(1) Present value of lease payment as on June 30, 2021:

Semi Annual Payment = $5,30,203

Incremental borrowing rate = 12% p.a.

Term = 4 years

As payment made semi annually,

Interest rate = 12×6÷12 = 6%

No. of periods = 4×2 = 8 periods

Present value = 5,30,203×PVAF(6%,8)

PVAF = [1-1÷(1+k)^n]÷k, where k is 6% and n is 8 periods

Present value = 5,30,203×[1-1÷(1+0.06)^8]÷0.06

Present value = 5,30,203×6.2098 = $32,92,455

As 1st payment has been made upfront Balance will be 32,92,455 - 5,30,203 = 27,62,252

Entry will be

On 30th June, 2021

Right of use Asset a/c Dr 32,92,455

To Lease Liability a/c 27,62,252

To Bank a/c 5,30,203

(2)What Pre tax amounts to the lease would Georgia Atlantic report in Balance sheet for Dec 31, 2021:

Entry will be

On Dec 31, 2021

Interest expense a/c Dr 1,65,753 (WN 1)

To Lease Liability a/c 1,65,753

Lease Liability a/c Dr 5,30,203

To Bank a/c. 5,30,203

Depreciation a/c Dr. 4,11,557 (WN 2)

To Right of use Asset a/c. 4,11,557

Profit and loss a/c Dr. 5,77,310

To Interest Expense a/c. 1,65,753

To Depreciation a/c. 4,11,557

Amount to be recorded under Assets side on 31st Dec 2021

Right to use Asset = 32,92,455

Less: Depreciation = (4,11,557)

Net cost of Asset. = 28,80,898

Under Liabilities side

Lease Liability. = 27,62,252

Less Payment of principal = (3,64,450)

Balance amount to be shown = 23,97,802

(3) What Pretax amount to the lease to be reported in Income statement for 31st Dec 2021:

Interest expense 1,65,753

Depreciation. 4,11557

Amount to be reflected in Income statement

= 5,77,310

WN 1: Amortization schedule of lease payments for Dec 31, 2021:

Year	Opening Balance of principal	Interest@6%	Annual Payment	Principal	Closing Balance of principal
On Dec 31st, 2021	27,62,252	1,65,753	5,30,203	3,64,450	23,97,802

WN 2: Depreciation schedule:

Term = 4 years

Value of Asset = 32,92,455

Depreciation under straight line method

(Cost - Salvage)÷ Useful life

= 32,92,455÷4 = 8,23,114 p.a.

From June 30 to Dec 31st 2021

Depreciation for 6 months = 8,23,114×6÷12 = 4,11,557