Question

High Time Tours leased rock-climbing equipment from Adventures Leasing on January 1, 2018. High Time has the option to renew the lease at the end of two years for an additional three years for $8,000 per quarter. Adventures purchased the equipment at a cost of $198,375.(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.)

Related Information:
Lease term	2 years (8 quarterly periods)
Lease renewal option for an additional	3 years at $8,000 per quarter
Quarterly lease payments	$15,000 at Jan. 1, 2018, and at Mar. 31, June 30, Sept. 30, and Dec. 31 thereafter.
Economic life of asset	5 years
Interest rate charged by the lessor	8%

Required:

1. Prepare appropriate entries for High Time Tours from the beginning of the lease through March 31, 2018. Appropriate adjusting entries are made quarterly.
2. Prepare an amortization schedule for the term of the lease.

Answer 1

Requirement 1

The lease term will be five years. The lease term for both the lessee and the lessor

is the contractual lease term modified by any renewal or termination options for which there is a significant economic incentive to exercise the options. The three-year renewal option can be exercised for significantly less than the original rate, which implies a significant economic incentive to extend the original lease term to five years.

Present Value of Lease Payments:

$15,000 x 7.47199*    =                                     $112,080 8,000 x 10.78685** = $86,295 x .85349*** = 73,652

$185,732

Because the 12 quarter annuity doesn’t begin for 8 quarters, $86,295 is its PV at that future time, and we need to multiply by .85349 to find its PV now.

* Present value of an annuity due of $1: n = 8, i = 2%

**Present value of an annuity due of $1: n = 12, i = 2%

***Present value of $1: n = 8, i = 2%

[i = 2% (8% ÷ 4) because the lease calls for quarterly payments.]

January 1, 2018

Right-of-use equipment ............................................                   185,732

Lease liability (present value calculated above) ....                            185,732

Lease liability ......................................................              15,000

Cash (lease payment) ..........................................                           15,000

April 1, 2018
Interest expense (2% x [$185,732 – 15,000]) .............	3,415
Lease liability (difference).....................................	11,585
Cash (lease payment) ..........................................		15,000

Amortization expense ($185,732 ÷ 20 quarters) .......                           9,287

Right-of-use equipment ..................................                            9,287

Requirement 2

Amortization Schedule:

Cash                                                                            Increase

Payments                           Effective   Interest            in Balance             Balance

185,732

1	15,000					15,000	170,732
2	15,000	.02	(170,732)	=	3,415	11,585	159,147
3	15,000	.02	(159,147)	=	3,183	11,817	147,330
4	15,000	.02	(147,330)	=	2,947	12,053	135,276
5	15,000	.02	(135,276)	=	2,706	12,294	122,982
6	15,000	.02	(122,982)	=	2,460	12,540	110,441
7	15,000	.02	(110,441)	=	2,209	12,791	97,650
8	15,000	.02	(97,650)	=	1,953	13,047	84,603
9	8,000	.02	(84,603)	=	1,692	6,308	78,295
10	8,000	.02	(78,295)	=	1,566	6,434	71,861
11	8,000	.02	(71,861)	=	1,437	6,563	65,298
12	8,000	.02	(65,298)	=	1,306	6,694	58,604
13	8,000	.02	(58,604)	=	1,172	6,828	51,776
14	8,000	.02	(51,776)	=	1,036	6,964	44,812
15	8,000	.02	(44,812)	=	896	7,104	37,708
16	8,000	.02	(37,708)	=	754	7,246	30,462
17	8,000	.02	(30,462)	=	609	7,391	23,072
18	8,000	.02	(23,072)	=	461	7,539	15,533
19	8,000	.02	(15,533)	=	311	7,689	7,844
20	8,000	.02	(7,844)	=	157	7,844	0