Question

Use the following to answer questions 10 through 13: Please explain and show work. Each time I do it I get different answers.

Montana Inc. sells computer systems. Montana leases computers to Utah Company on June 30, 2017. The computers cost Montana $12 million to manufacture. The lease is non-cancelable and has the following terms:

Lease payments: $2,466,754 semiannually; first payment due June 30, 2017; remaining payments due December 31 and June 30 each year through December 31, 2021.

Lease term: 5 years (10 semi-annual payments).

No residual value; no bargain purchase option.

Economic life of equipment: 5 years.

Implicit interest rate and lessee's incremental borrowing rate: 10% per year.

Fair value of the computers at June 30, 2017: $20 million.

Collectability of the rental payments is reasonably assured, and there are no lessor costs yet to be incurred.

10. Montana would account for this lease as:
A) A finance lease.
B) A sales type lease without selling profit.

C) A sales type lease with selling profit.

D) An operating lease.

11. Utah Company would account for this lease as:

A) A finance lease.
B) A sales type lease without selling profit.

C) A sales type lease with selling profit.

D) An operating lease.

12. The net carrying value of the lease liability on Utah's books after the December 31, 2017 payment is closest to:
A) $15,943,154
B) $17,533,246

C) $21,000,000

D) $15,066,492

13. Total interest revenue Montana would report on its year end December 31, 2017 income statement relative to this lease is closest to:
A) $4,933,508
B) $1,673,820

C) $876,662

D) $2,466,754

Answer 1

1. Montana should account for this lease as a sale type lease with selling profit since the period of lease is that of entire useful life of the asset with no residual value and the present value of total lease payments to be received is significantly higher than the cost of the asset.
2. Again Utah Company would also account or this lease as finance lease since the lease period is same as the useful life of the asset.

Semi-annual payments	Present value factor @5% per six months
2466754	0.952381	2349290
2466754	0.907029	2237419
2466754	0.863838	2130875
2466754	0.822702	2029405
2466754	0.783526	1932766
2466754	0.746215	1840730
2466754	0.710681	1753076
2466754	0.676839	1669596
2466754	0.644609	1590092
2466754	0.613913	1514373
Total liability at the beginning		19047621
Less: Lease payment as on June 30, 2017		2466754
Liability as on June 30, 2017 after payment of first instalment		16580867
Add: Interest @5% up-to December 31, 2017		829043.3
Lease liability as on December 31, 2017 before payment of lease		17409910
Less: Lease payment as on December 31, 2017		2466754
Lease liability as on December 31, 2017		14943156

Note: Present value factor has been taken at 5% as the annual rate of borrowing is 10% thus, semi-annual rate of interest to discount the cash flow is 5%, i.e. (10% x 6/12).

Hence, the net carrying value of the lease liability on Utah’s book after 31^st December, 2017 payment is closest to option D, i.e. $15,066,492.

Interest @5% up-to December 31, 2017

829043.3

Total interest revenue Montana would report on its year end December 31, 2017 income statement relative to this lease is closest to option C, i.e. 876,662.