Question

At January 1, 2018, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $29,000 beginning January 1, 2018, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was acquired recently by Crescent at a cost of $216,000 (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 9 years, the asset does have an expected residual value at the end of the lease term of $76,131.). Both (a) the present value of the lease payments and (b) the present value of the residual value (i.e., the residual asset) are included in the lease receivable because the two amounts combine to allow the lessor to recover its net investment. Crescent seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1).

What is the effect on earnings for the lessor?

Answer 1

First of all we need to calculate the lease receivable on the date of lease

Lease Receivable = PV of Annual Lease payments+PV of residual value

= Annual lease payments*[1+PVAF(10%, 8 yrs)]+Residual value*PVF(10%, 9 yrs)

= [$29,000*(1+5.33493)]+($76,131*0.424098)

= $183,713+$32,287 = $216,000

Lease Receivable balance as on January 1, 2018 after receipt of first lease payment

= $216,000 - $29,000 = $187,000

Interest Income on lease for year 2018 = $187,000*10% = $18,700

Therefore the earnings for the lessor will increased by $18,700 in the year 2018 (first year of lease).

Lease Amortization Schedule (Amount in $)

Date	Annual Lease Payment (A)	Interest (B = Outstanding bal.*10%)	Decrease in Balance (A-B)	Outstanding Balance
1/1/18	29,000	0	29,000	(216,000-29,000) = 187,000
12/31/18	29,000	(187,000*10%) = 18,700	10,300	(187,000-10,300) = 176,700
12/31/19	29,000	(176,700*10%) = 17,670	11,330	(176,700-11,330) =165,370
12/31/20	29,000	(165,370*10%) = 16,537	12,463	(165,370-12,463) = 152,907
12/31/21	29,000	(152,907*10%) = 15,291	13,709	(152,907-13,709) = 139,198
12/31/22	29,000	(139,198*10%) = 13,920	15,080	(139,198-15,080) = 124,118
12/31/23	29,000	(124,118*10%) = 12,412	16,588	(124,118-16,588) = 107,530
12/31/24	29,000	(107,530*10%) = 10,753	18,247	(107,530-18,247) = 89,283
12/31/25	29,000	(89,283*10%) = 8,928	20,072	(89,283-20,072) = 69,211
12/31/26		(76,131-69,211) = 6,920 (Bal. fig as interest)		76,131

Workings:

1) On the last day of lease (i.e. on Dec 31, 2026) the interest is taken as balancing figure to avoid rounding off difference. ($76,131 - $69,211 = $6,920).