Question

Each of the three independent situations below describes a finance lease in which annual lease payments are payable at the beginning of each year. The lessee is aware of the lessor’s implicit rate of return. (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.) Situation 1 2 3 Lease term (years) 10 20 4 Lessor's rate of return (known by lessee) 10% 8% 11% Lessee's incremental borrowing rate 11% 9% 10% Fair value of lease asset $760,000 $1,140,000 $345,000 Required: a. & b. Determine the amount of the annual lease payments as calculated by the lessor and the amount the lessee would record as a right-of-use asset and a lease liability, for above situations. (Round your answers to nearest whole dollar.)

Answer 1

Solution :

Situation 1:

a) Annual lease payments = Fair value of leased assets / Cumulative PV factor for annuity due at 10% for 10 years

= $760,000 / 6.759024 = $112,442

b) Amount the lessee would record as a right-of-use asset and a lease liability = $112,442 * 6.759024 = $760,000

Situation 2:

a) Annual lease payments = Fair value of leased assets / Cumulative PV factor for annuity due at 8% for 20 years

= $1,140,000 / 10.60360 = $107,511

b) Amount the lessee would record as a right-of-use asset and a lease liability = $107,511 * 10.60360 = $1,140,000

Situation 3:

a) Annual lease payments = Fair value of leased assets / Cumulative PV factor for annuity due at 11% for 4 years

= $345,000 / 3.443715 = $100,183

b) Amount the lessee would record as a right-of-use asset and a lease liability = $100,183 * Cumulative PV factor at 10% for 4 periods

= $100,183 * 3.486852 = $349,323

But since this amount exceeds the asset’s fair value, the lessee must capitalize the $345,000 fair value instead.