Question

At January 1, 2018, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $32,000 beginning January 1, 2018, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was acquired recently by Crescent at a cost of $243,000 (its fair value) and was expected to have a useful life of 13 years with no salvage value at the end of its life. (Because the lease term is only 9 years, the asset does have an expected residual value at the end of the lease term of $97,756.). Both (a) the present value of the lease payments and (b) the present value of the residual value (i.e., the residual asset) are included in the lease receivable because the two amounts combine to allow the lessor to recover its net investment. Crescent seeks a 9% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. (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. What will be the effect of the lease on Crescent’s earnings for the first year (ignore taxes)? (Enter decreases with negative numbers.)
2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Crescent (ignore taxes)?

Answer 1

Particulars
Negotiated selling price	243,000.00000
Residual value	97,756.00
Term of lease (in months)	108
Interest rate	9%
Net capitalized cost	243,000.00000
Deprication fee	1,344.85185
Money factor	0.00375
Financing fee	1,277.83500
Monthly lease payment	2,622.68685
Annual lease paymnet	31,472.24222
Convert no of years to no of months by multiplying the years with 12.

1) Effect of the lease on Crescent’s earnings for the first year

• Balance Sheet: The lease receivable is reported. The value is derived from the present value of lease payments in future. Also, the assets are reduced by the book value of the leased asset.
• Income Statement: The interest revenue is reported. It is calculated on the lease receivable at the beginning using the interest rate in the lease.
• Cash Flow Statement: The interest component of the lease revenue is reported as an operating cash inflow and the principal component of the payment is reported as an investing cash inflow.

2)

Assets		Liabilities
Equipment	243,000.00		Financial lease	226,861.80
Less: Depreciation	16,138.20
Net value of equipment		226,861.80