Question

yates Corporation enters into an agreement with Browning Rentals Co. on January 1, 2020 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement:

(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year.

(b) The fair value of the machine on January 1, 2020, is $1,660,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease.

(c) Yates depreciates all machinery it owns on a straight-line basis.

(d) yates’s incremental borrowing rate is 10% per year. yates does not have knowledge of the 8% implicit rate used by Browning.

A) If Browning records this lease as a financing lease, what amount would be recorded as Lease Receivable at the inception of the lease? Show all of your work. a. $574,864 b. $1,572,563 c. $1,600,000 d. $1,724,592

B) How much depreciation expense would Browning, the lessor, show in Year 1 for this asset?

C) How much Interest Revenue would Browning show in Year 1 on this transaction?

D) Which of the following lease-related revenue and expense items would be recorded by Browning if the lease is accounted for as an operating lease? a. Lease Revenue only b. Interest Revenue only c. Depreciation Expense only d. Lease Revenue and Depreciation Expense

Answer 1

Answers

A .c. $1,600,000

At the inception, lessor-Browing shall recognise assets held under a finance lease in the balance sheet and present them as receivable at an amount equal to the net investment in the lease

Net investment = Present value of lease payment + PV of unguaranteed residual value.

Discount rate =Implicit rate 8%

Year	Lease payment	PV factor @8%	Pv of lease payments
1	$5,74,864	1	$5,74,864.00
2	574864	0.9259259	$5,32,281.47
3	574864	0.8573388	$4,92,853.21
	Net investment in lease(Receivables)	$16,00,000.68

B. Depreciation expense is zero,

In a finance lease, at the inception Browing (lessor) derecognises the carrying amount of underlying asset and recognise the net investment in the lease. hence no depreciation.

C. Interest element in the first payment is Zero because the payment made on January 1 of each year, which means the payment made in advance.

D.d. Lease Revenue and Depreciation Expense.

In operating, lease lessor should recognise lease rental as income and depreciation as an expense.