Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $25,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $180,000 (its fair value) and was expected to have a useful life of 12 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 $50,995.) 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 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease to the lessee. (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 sign.)
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)

Effect on earnings	???
Lease receivable balance (end of year)	???

Answer 1

Table showing the total of Present Value of Lease Rentals and the residual value

Date	Particulars	Amount ($)	PVIF @ 10%	Amount ($)
01/01/2021	Lease Rentals	25000	1	25000
31/12/2021	Lease Rentals	25000	0.909	22725
31/12/2022	Lease Rentals	25000	0.826	20650
31/12/2023	Lease Rentals	25000	0.751	18775
31/12/2024	Lease Rentals	25000	0.683	17075
31/12/2025	Lease Rentals	25000	0.621	15525
31/12/2026	Lease Rentals	25000	0.564	14100
31/12/2027	Lease Rentals	25000	0.513	12825
31/12/2028	Lease Rentals	25000	0.467	11675
31/12/2029	Residual Value	50995	0.424	21650 (Here $30 more has been added to equal the value to 180000)
				180000

Notes :

i) Here the residual value given is after expiry of 9 years from the beginning of the lease term i.e 01/01/2021 so the residual value is given for 31/12/2029.

ii) Here the value of Present value and residual value is equal to the cost of the asset.

iii) PVIF(r,t) = 1/((1+r)^t) where r=rate of return t=time period

1) Effect of Lease on Cresent's Earning's for the first year

Cresent will earn a lease rental of $25000 each on 01/01/2021 amd 31/12/2021 total $50000. Since the given lease is a finance lease Cresent will not be able to claim the depreciation of $15000 (180000/12)

2) Balance in the balance sheet related to the lease account at the end of the first year i.e for the period ended 31/12/2021

Particulars	Amount ($)
Lease Receivable	180000
Less : First Installment 01/01/2021	25000
Less: Second Installment 31/12/2021	25000
Add: Finance Charges	15500
Closing Blance	145500
Current Portion (25000- 14550)	10450
Non-Current Portion	135050

Lease Receivable Schedule

Date	A.Balance	B.Interest (+)	C.Installment (-)	Closing (A+B-C)
01/01/2021	180000	-	25000	155000
31/12/2021	155000	15500	25000	145500
31/12/2022	145500	14550	25000	135050
31/12/2023	135050	13505	25000	123555
31/12/2024	123555	12356	25000	110911
31/12/2025	110911	11091	25000	97002
31/12/2026	97002	9700	25000	81702
31/12/2027	81702	8170	25000	64872
31/12/2028	64872	6487	25000	46359
31/12/2029	46359	4636	50995	-