Question

Exercise 15-12 Lessor calculation of annual lease payments; lessee calculation of asset and liability [LO15-5] Each of the three independent situations below describes a capital 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 5 Lessor’s rate of return (known by lessee) 11% 9% 12% Lessee’s incremental borrowing rate 12% 10% 11% Fair value of leased asset $720,000 $1,100,000 $305,000 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 leased asset/liability, for above situations.

Answer 1

1. Calculation of Annual Lease payments by lessor

Case 1:

Value of Asset = 720,000

Lessor rate of return = 11%

Tenure = 10 years

Cumulative present value at 11% = 1+ [1 / (1.11)¹] + [1+(1.11)²] + ...........[1+(1.11)⁹]

= 6.537

Annual Lease Payment = Total Value of Asset / 6.537

= 720,000 / 6.537 = $110,142.26

Case 2:

Value of Asset = 1,100,000

Lessor rate of return = 9%

Tenure = 20 years

Cumulative present value at 9% = 1+ [1 / (1.09)¹] + [1+(1.09)²] + ...........[1+(1.09)¹⁹]

= 9.95

Annual Lease Payment = Total Value of Asset / 9.95

= 1,100,000 / 9.95 = $110,552.76

Case 3:

Value of Asset = 305,000

Lessor rate of return = 12%

Tenure = 5 years

Cumulative present value at 12% = 1+ [1 / (1.12)¹] + [1+(1.12)²] + ...........[1+(1.12)⁴]

= 4.037

Annual Lease Payment = Total Value of Asset / 4.037

= 305,000 / 4.037 = $75,551.15

NOTE:

a. Since the payments are made beginning of year. cumulative value will be 1 + (present value of number of year - 1)