Question

On June 30, 2018, Georgia-Atlantic, Inc., leased warehouse equipment from Builders, Inc. The lease agreement calls for Georgia-Atlantic to make semiannual lease payments of $478,767 over a 4-year lease term, payable each June 30 and December 31, with the first payment at June 30, 2018. Georgia-Atlantic's incremental borrowing rate is 9.0%, the same rate Builders used to calculate lease payment amounts. Builders manufactured the equipment at a cost of $2.8 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 price at which Builders is “selling” the equipment (present value of the lease payments) at June 30, 2018.
2. What amounts related to the lease would Builders report in its balance sheet at December 31, 2018 (ignore taxes)?
3. What amounts related to the lease would Builders report in its income statement for the year ended December 31, 2018 (ignore taxes)?

Answer 1

Solution 1:

Semiannual lease payment to be received = $478,767

Total semiannual payments to be received = 4*2 = 8

Incremental borrowing rate = 9%, 4.5% semiannual

Price at which Builders is “selling” the equipment = Semi Annual lease payments * Cumulative PV Factor of annuity due for 8 periods at 4.50%

= $478,767 * 6.89270 = $3,299,998

Solution 2:

Semiannual payment received on 30.06.2018 = $478,767

Pretax amount of receivables on 30.06.2018 = ($3,299,998 - $478,767) = $2,821,231

Interest revenue for 31.12.2018 = $2,821,231 * 4.50% = $126,955

Semiannual lease payment received on 31.12.2018 = $478,767

Pre tax amount for receivables on December 31, 2018 = $2,821,231 + $126,955 - $478,767 = $2,469,419

Solution 3:

Pre tax amount of interest Revenue Builder Inc. reports in its income statement = $2,821,231 * 4.50% = $126,955

Pre tax amount of revenue Builder Inc. reports in its income statement = $3,299,998

Pre tax amount of cost of goods sold to be reported by Builder Inc. in its income statement = $2,800,000

Amounts related to the lease would Builders report in its income statement for the year ended December 31, 2018 = $126,955 + $3,299,998 - $2,800,000 = $626,953