Question

On June 30, 2016, Blue, Inc., leased a machine from Big Leasing Corporation. The lease agreement qualifies as a capital lease and calls for Blue to make semiannual lease payments of $214,208 over a four-year lease term, payable each June 30 and December 31, with the first payment at June 30, 2016. Blue’s incremental borrowing rate is 12%, the same rate Big uses to calculate lease payment amounts. Depreciation is recorded on a straight-line basis at the end of each fiscal year. (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.)

1. Determine the present value of the lease payments at June 30, 2016, (to the nearest $000) that Blue uses to record the leased asset and lease liability.

Present Value:

2. What would be the pretax amounts related to the lease that Blue would report in its balance sheet at December 31, 2016?

Leased asset:

Leased liability:

3. What would be the pretax amounts related to the lease that Blue would report in its income statement for the year ended December 31, 2016?

Pretax amount:

Answer 1

1	Computation of present value of lease payment at June 30, 2016:-
	Present value	=	Semiannual lease payment X Present value Annuity Dueo of $1 (n=8, i=6%)
		=	$2,14,208 X 6.58238
		=	$14,09,998
	or	=	$14,10,000	(rounded off)
	[Note: Payments are done semiannually, Therefore Total intereset rate shall be (12%/2) = 6% and number of payments over 4 years are (4 X 2) = 8 years]
2	Computation of pretax amount related to lease to be reported in balancesheet December 31, 2016
	Leased Asset:
	Initial balance , June 30,2016	=	$14,10,000
Less:	Accumulated Depreciation, December 31, 2016	=	$   1,76,250
	Leased Asset December 31, 2016	=	$12,33,750
	Workings:
	Depreciation Expense	=	$3,52,500 / 8
			$   1,76,250
	Leased Liability:
	Initial balance , June 30,2016	=	$14,10,000
Less:	Reduction, June 30, 2016 (first installment)	=	$   2,14,208
Less:	Reduction, December 31, 2016	=	$   2,85,956
	Leased Liability	=	$   9,09,837
	Workings:
	Reduction, December 31, 2016	=	Semiannual payment + Interest expense
		=	$2,14,208 + $71,748
		=	$   2,85,956
	Interest Expense	=	Remaining amount X 6%
		=	($14,10,000 - $2,14,208) X 6%
		=	$      71,748
3	Computation of pretax amount related to lease to be reported in balancesheet December 31, 2016
	Pretax amount:
	Interest Expense, June 30, 2016	=	0
	Interest Expense, December 31, 2016	=	$      71,748
	Interest Expense for 2016	=	$      71,748
	Depreciation Expense for 2016	=	$   1,76,250
	Total Expense	=	$   2,47,998