Question

Case 1- Determining Lease Capitalization Amounts

Hill Corporation, a diversified manufacturing company, has offices and operating locations in major cities throughout the United States. The corporate headquarters for Hill Corporation is located in Chicago, Illinois, and employees connected with various phases of company operations travel extensively. Corporate management is currently evaluating the feasibility of acquiring a business aircraft that can be used by company executives to expedite business travel to areas not adequately served by commercial airlines. Proposals for either leasing or purchasing a suitable aircraft have been analyzed, and the leasing proposal was considered to be more desirable. The proposed lease agreement involves a fully equipped business jet that has a fair value of $10,000,000. This plane would be leased for a period of 10 years beginning January 1, 2016. The lease agreement is cancelable only upon accidental destruction of the plane. An annual lease payment of $1,417,800is due on January 1 of each year; the first payment is to be made on January 1, 2016. Maintenance operations are scheduled by the lessor, and Hill Corporation will pay for these services as they are performed. Estimated annual maintenance costs are $69,000. The lessor will pay all insurance premiums and local property taxes, which amount to a combined total of $40, 000 annually and are included in the annual lease payment of $1,417,800. Upon expiration of the 10-year lease, Hill Corporation can purchase the CJ4 for $444,400. The estimated useful life of the plane to Hill is 10 years, and its salvage value in the used plane market is estimated to be $750,000.If the purchase option is not exercised, possession of the plane will revert to the lessor, and there is no provision for renewing the lease agreement beyond its termination on December 31, 2023. Hill Corporation can borrow $10,000,000 under a 10-year term loan agreement at an annual interest rate of 12%. The lessor's implicit interest rate is not expressly stated in the lease agreement, but this rate appears to be approximately 8% based on 10 annual net rental payments and the initial fair value of $10,000,000 for the plane. On January 1, 2016, the present value of all net rental payments and the purchase option of $444,440 is $8,888,900 using the 12% interest rate. The present value of all net rental payments and the $44,440 purchase option on January 1, 2016, is $10,222,260 using the 8% interest rate implicit in the lease agreement. The controller of Hill Corporation has established that this lease agreement is a capital lease as defined in GAAP. Hill has not early adopted ASU 2016-02.

Required:

What is the appropriate amount that Hill Corporation should recognize for the leased aircraft on its balance sheet after the lease is signed?

Assume instead that the annual lease payment is $1,417,800, that the appropriate capitalized amount for the leased aircraft is $10,000,000 on January 1, 2016, the interest rate is 9% and that the lease term is 10 years. How will the lease be reported on Hill’s December 31, 2016, balance sheet and related income statement? (Ignore any income tax implications.)

Answer 1

Effective Interest Rate of Lessor is Approximately given as 8% that should be used for Lease calculation purpose.(Not lesse borrowing rate)

Executory costs such as maintenance and insurance are usually excluded because they are the responsibility of the lessor

Value of Lease will be Lower of:

Fair Value of leased Asset	10,000,000	Lower
Pv Of minimum Lease payment(inc. any ,Bargain-Purchase Option)	10,222,260
(Net Rent Payments &purchase option)@8%lessor impl INT rate

The Lower 10,000,000 will be the amount that Hill Corporation should recognize for the leased aircraft on its balance sheet

B)

Amortisation Table For Capital Lease-Advance Payments

Year	Opening	Lease Payment	o/s	Effective INT (9%)	Closing
2016	10,000,000	(1,417,800)	(10,000,000-1,417,800)=8,582,200	(8,582,200 * 9%)=772,398	(8,582,200+772,398)=9,354,598
2017	9,354,598	(1,417,800)	7,936,798	714,312	8,651,110

-Opening will be lesser of 1st table( In this case it is requirement as 10,000,000) both makes same

-As Lease Payment in advance interest calculate after deducting from opening balance

Liability- 9,354,598 Will be the Balance Sheet Liability Item

SPLIT Non-Current Liability - 8,651,110

Current Liability (9,354,598-8,651,110) -703,488

As 703,488 value for month period andother as NCL