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 nine years, the asset does have an expected residual value at the end of the lease term of $50,995.) Crescent seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. 

 

Required: 

1. What will be the effect of the lease on Café Med’s earnings for the first year (ignore taxes)? 

2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year of Café Med (ignore taxes)?

Answer 1

1.
Right to use assets
Annual lease payment	25000
*cumulative PV factor for annuity due at 10% for 9 periods	6.334926
Right to use assets	158373
Interest expesne [(158373-25000)*10%]	-13337
Amortization for the year (158373/9)	-17597
Effect on earnings for first year	-30934
2.
Lease payable balance (End of year)
beginning balance	158373
Add: Interest expense	13337
less: Payments (annual payment *2)	50000
Lease payable balance (end of year)	121710
Right of use asset balance (end of year)
beginning balance	158373
Less: Amortization	17597
Right of use asset balance (end of year)	140776

1.
Right to use assets
Annual lease payment	25000
*cumulative PV factor for annuity due at 10% for 9 periods	6.334926
Right to use assets	158373