Question

On January 2, 2017 Nash Company leases a machine with a fair value of $34,000 from Snead, Inc., on the following terms:

1.		Noncancelable term of 4 years.
2.		Rental of $8,400 per year (at beginning of each year).
3.		Estimated residual value after 4 years is $4,200. Nash Company guarantees the residual value of $4,200.
4.		Estimated economic life of the machine is 5 years.
5.		Nash Company’s incremental borrowing rate is 8% a year. Snead’s implicit rate is unknown.

Instructions:

What is the present value of the minimum lease payments?

Record the lease and first lease payment on Nash Company’s books at the date of inception.

Record the first year’s depreciation on Nash Company’s books (assume straight-line).

Record the interest payable on Nash’s books at December 31, 2017.

Answer 1

Nash Company leases a machine with a fair value of $34,000
Noncancelable term of 4 years.
Rental of $8,400 per year (at beginning of each year).
Estimated residual value after 4 years is $4,200. Nash Company guarantees the residual value of $4,200.
Estimated economic life of the machine is 5 years.
Nash Company’s incremental borrowing rate is 8% a year. Snead’s implicit rate is unknown.
What is the present value of the minimum lease payments?
PV of lease Payments
Annual Payment*Sum of PV of 10% for 0 to 3 years						$ 30,047.61
(8400*3.577097)
PV ofGuaranteed esidual Value (GRV*PVF of 8% of 4th year						$    3,087.13
(4200*0.73503)
Present Valueof minimum lease payment						$ 33,134.74
Record the lease and first lease payment on Nash Company’s books at the date of inception.
Machine on Lease A/c Dr			$ 33,134.74
	To Lesse Liability A/c			$ 33,134.74
Lease Liability			$    8,400.00
	To Bank			$    8,400.00
Record the first year’s depreciation on Nash Company’s books (assume straight-line).
Depreciation A/c			$    7,233.69	[33134.74-4200]/4 year
	To Machine on lease		$                 -	$    7,233.69
Record the interest payable on Nash’s books at December 31, 2017
Finance Cost A/c Dr			$    1,978.78
	To Lease Liability			$    1,978.78
Calculation of Interest Cost
				Lease Liability
02.01.2017	Value of asset			$ 33,134.74
Less: Payment Made on 02.01.2017				$    8,400.00
Lease Liability as on 31.12.2017				$ 24,734.74
Interest Exp @ 8%				$    1,978.78