Question

At January 1, 2021, Alpha leased restaurant equipment from Payne Corporation under a six-year lease agreement in a finance lease. The lease agreement specifies annual payments of $40,000
beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was acquired recently by Payne at a cost of $250,000 and was expected to
have a useful life of eight years with no salvage value at the end of its life. Payne seeks a 8% return on its lease investments. The total decrease in earnings (pretax) in Alpha December 31, 2021,
income statement would be:
(Do not add dollar sign; do not add comma by yourself to your amount; round the answer to the whole number)Google.

the pva & pvad tables are on Google so you can use those.

there is no option? that is the full question. answer it or don't but there's no more information.

Answer 1

In the above case, the lessee is Alpha and the lessor is Payne.

IFRS lays down the criteria for deciding the nature of the lease if the terms with respect to transfer of risks and rewards is not clear. They are :

1. Option to purchase of asset by the lesssee at a price lower than its fair value at a future date mostly at the end of the term of the lease The option has to be decided upon at the beginning of the lease period .
2. The life of the lease is for a major portion of the useful economic life of the asset ideally ,75% or more.
3. The net present value of the minimum lease payments has to be at least  90% of the asset’s fair value on date of the start of the lease.

If we verify on the above grounds we can conclude that it is a finance lease because though the criteria1 and 3 are not met , criteria 2 is met .Criteria 2 is met as the major portion of life of asset is covered by the lease ( 6 out of 8 years which is 75%)

Under the Finance lease , the principal and interest payments are recorded on the income statement of the lessee .

The principal repayments are treated as the depreciation in the income statement of the lessee i.e Alpha here. The principal will be amortized over the life of the lease.

The decrease in pre tax earnings for December 31,2021 will be 80,000(calculated below)

	Working notes :
1	PV of future lease annual payments
Year	Date of payment	PVF @ 8%	PV of lease payments
			( 40,0000 x PVF)
1	1.1.21	1	40,000
2	31.1.21	0.9259	37,037
3	31.1.21	0.8573	34,294
4	31.1.22	0.7938	31,753
5	31.1.23	0.7350	29,401
6	31.1.24	0.6806	27,223
	31.1.25		199,708
	8% will be treated as the discounting factor.
	Value of annual payments of lease ( 40,000 x 6)	$           240,000.00
	PV of lease as compared to Fair value of asset (199708/240000)	83.21%

2	Lease Interest :
	Fair value of annual payments	$40000 x 6	240,000
	Total lease payments		199,708
	Interest		40,292

3	Amortization schedule :
Year	Date	Lease payment	Interest expense @ 8%	Amortization	Finance Lease liability
1	1.1.21			40,000	159,708	( 199708-40000)
2	31.1.21	159,708	12,777	27,223	132,485
3	31.1.22	132,485	10,599	29,401	103,084
4	31.1.23	103,084	8,247	31,753	71,331
5	31.1.24	71,331	5,706	34,294	37,037
6	31.1.25	37,037	2,963	37,037	-
			40,292	199,708

Though there will be no interest on 40,000 paid on 1st Jan 2021. However the 40,000 will be treated as the principal repayment and hence taken as depreciation .

Decrease in pre tax earnings for December 31,2021
Depreciation	40000+27223	67,223
Interest		12,777
		80,000