Question

Delaney Company leases an automobile with a fair value of $10,000 from Simon Motors, Inc., on the following terms. 1. Non-cancelable term of 50 months. 2. Rental of $200 per month (at the beginning of each month). (The present value at 0.5% per month is $8,873.) 3. Delaney guarantees a residual value of $1,180 (the present value at 0.5% per month is $920). Delaney expects the probable residual value to be $1,180 at the end of the lease term. 4. Estimated economic life of the automobile is 60 months. 5. Delaney’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown. Instructions (a) What is the nature of this lease to Delaney? (b) What is the present value of the lease payments to determine the lease liability? (c) Based on the original fact pattern, record the lease on Delaney’s books at the date of commencement. (d) Record the first month’s lease payment (at commencement of the lease). (e) Record the second month’s lease payment. (f) Record the first month’s amortization on Delaney’s books (assume straight-line). (g) Suppose that instead of $1,180, Delaney expects the residual value to be only $500 (the guaranteed amount is still $1,180). How does the calculation of the present value of the lease payments change from part (b)? Please be sure to use current law change

Answer 1

ques 1
this is finance lease because
1)the lease is greater than (50/60 months) 75% of the economic life of lease asset
2)
the present values of the lease payments for purposes of classifying the lease
is greater than 90% of fair value ($10000)
PV of monthly payment of $200 for 50 months					8873
PV of residual value					920
Present value of lease payment					9793
ques 2
to determine lease liability the lessee should only include the present
value of gauranteed residual value probable to be owed under lease agreement
since the expected residual value is same as gauranteed residual value
no amounts are probable
so the lease liability is therefore
PV of monthly payment of $200 for 50 months					8873
Ques 3
		debit	credit
Right of use asset		8873
lease liability			8873
ques 4
		debit	credit
Lease liability		200
Cash			200
ques 5
		debit	credit
Lease liability		157
interest expense		43
((8873-200)*0.5%)
Cash			200
ques 6
		debit	credit
Amortization expense		177
Right of use asset			177
(8873/50 months)
ques 7
because the expected residual value(500) is less
than the gauranteed residual value(1180) the present
value of lease payment is calculated as follows
PV of monthly payment of $200 for 50 months				8873
PV of residual value[(1180-500)*0.77929]				530
Present value of lease payment				9403