Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $25,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $180,000 (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 $50,995.) 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) (Use appropriate factor(s) from the tables provided.)
  
Required:
1. What will be the effect of the lease on Café Med’s earnings for the first year? (ignore taxes) (Enter decreases with negative sign.)
2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Café Med? (ignore taxes)
(For all requirements, round your intermediate calculations and final answers to the nearest whole dollars.)

Effect on earning	???
Lease payable balance (end of year)	???
Right of use asset balance (end of year)	???

Answer 1

Effect on earning	$ -25,000
Lease payable balance (end of year)	$ 1,21,710
Right of use asset balance (end of year)	$ 1,46,710
1)
Effect of the lease on Café Med’s earnings for the first year	$ -25,000.00
Income Statement:
Interest (10% × [$158372.50 – $25,000]	$ 13,337.25
Amortization for the year ($25,000 – $13,337.25)	$ 11,662.75
Lease expense; decrease in earnings (pretax)	$ 25,000.00
Initial Balance = $25000 x 6.3349*	$ 1,58,372.50
* Present value of an annuity due of $1: n = 9, i = 10%	6.3349
2)
Balance sheet
Lease payable balance (end of year)	$ 1,21,710
Right-of-use asset balance (end of year)	$ 1,46,710
Lease payable
Initial Balance = $25000 x 6.3349	$ 1,58,372.50
Jan. 1, 2021 reduction (first lease payment)	$ -25,000.00
Dec. 31, 2021 reduction ($25,000 – 10% × [$158,372.50 – $25,000]	$ -11,662.75
End-of-year balance	$ 1,21,709.75