Question

Larkspur Company leases an automobile with a fair value of $10,844 from John Simon Motors, Inc., on the following terms:

1.		Non-cancelable term of 50 months.
2.		Rental of $220 per month (at the beginning of each month). (The present value at 0.5% per month is $9,760.)
3.		Larkspur guarantees a residual value of $1,120 (the present value at 0.5% per month is $873). Delaney expects the probable residual value to be $1,120 at the end of the lease term.
4.		Estimated economic life of the automobile is 60 months.
5.		Larkspur’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown.

A. Record the second month’s lease payment. (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 0 decimal places, e.g. 5,275.)

B. Record the first month’s amortization on Larkspur’s books (assume straight-line). (Credit account titles are automatically indented when amount is entered. Do not indent manually. Round answers to 2 decimal places, e.g. 5,275.25.)

C. Suppose that instead of $1,120, Larkspur expects the residual value to be only $500 (the guaranteed amount is still $1,120). How does the calculation of the present value of the lease payments change from part (b)? (Round answer to 0 decimal places, e.g. 5,275.)

Answer 1

In the books of Larkspor Company

A. Lease receivable DR. $220.00

To Lease income CR $220.00

(Being lease income recognised for the 2nd month)

Lease income DR $220.00

To profit & loss account CR $220.00

(Being lease income transferred to profit and loss account)

B. As per IAS-17 Assets should be recorded as minimum of these two:-

(i) Fair value of assets ie $10,844

or

(ii) Present value of minimum lease payments ie (Rental recived+ Guranteed residual value)

= 9760+873

= $10,633

So Automobile should be recorded at $10,633.00

so the amortization value will be as per straight line method would be = (Value of asset - residual value)/ no of months

=(10633-1120)/60

= $158.55

C. Present value of minimum lease payment = Present value of ( Rent receivable+ Guranteed residual value+ unguranteed residual value)

= 9760+873+389

= $ 11,022

But the value of assets would be recorded as minimum of these two

i. fair value of assets ie 10,844

ii. Present value of minimum lease payments ie 11,022

so it should be recorded at $ 10,844.00 .