Question

A lease agreement that qualifies as a finance lease calls for annual lease payments of $24,000 over a four-year lease term (also the asset’s useful life), with the first payment at January 1, the beginning of the lease. The interest rate is 5%. (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:
a. Determine the present value of the lease upon the lease's inception.
b. Create a partial amortization through the first payment on January 1, 2017.
c. If the lessee’s fiscal year is the calendar year, what would be the pretax amounts related to the lease that the lessee would report in its income statement for the first year ended December 31?

Answer 1

a.	Computation of present value of lease upon lease's inception:
	Lease payment	=	$     24,000
	Interest rate	=	5%
	Number of yesrs	=	4 year
	No of lease payments	Year	Value Flows	Present Factor @ 5%	Present Value
	1	0	$     24,000	1	$        24,000
	2	1	$     24,000	0.95238	$        22,857
	3	2	$     24,000	0.90703	$        21,769
	4	3	$     24,000	0.86384	$        20,732
	Net Present Value				$        89,358
b.	Computation of partial amortization through the first payment on January 1, 2017 :
	Initial cost	=	$     89,358
Less:	First lease payment	=	$     24,000
	Net liability	=	$     65,358
	Effective interest ($65,358 X 5%)	=	$ 3,267.90
	Date	Lease payment	Effective interest	Decrease in balance	Outstanding balance
	01-01-2016				$        89,358
	01-01-2016	$   24,000	0	$       24,000	$        65,358
	01-01-2017	$   24,000	$ 3,267.90	$ 20,732.10	$ 44,625.85
c.	Computation of impact on pretax income related to lease :
	Interest Expense	=	$        3,268
	Amortization expense ($89,358 / 4 years)	=	$     22,339
	Pre tax earnings shall be reduced by	=	$     25,607