Question

The information below relates to a leasing arrangement between Summer Leasing Company and Talon Company, a lessee.
Inception date January 1, 2020
Lease term 6 years
Annual lease payment due at the beginning of
each year, beginning with January 1, 2020 $150,000
Fair value of asset at January 1, 2020 $760,000
Economic life of leased equipment 7 years
Residual value of equipment at end of lease term,
guaranteed by the lessee $65,500
Lessor’s implicit rate 10%
Lessee’s incremental borrowing rate 12%
January 1, 2020
The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $65,500. The lessee uses the straight-line depreciation method for all equipment.
Instructions
(i) What is the lease liability for Talon Company?
(ii) Record the lease on Talon Company’s books at the date of inception.
(iii)Record the first year’s depreciation on Talon Company’s books.

Answer 1

SOLUTION:-

The incremental borrowing rate of lessee is 12% For calculation of lease liability of lessee, Telsan company incremental borrowing rate of 12% should be considered.

Since the lessee has guaranteed the lessor residual value. residual value also should be considered for calculation of lease liability of Telsan company.

(i)

Calculation of Lease liability for Telsan company
Date	Installment/Residual value	PF Factor @ 12%	PV of MLP
January 1,2020	$ 1,50,000	1	$ 1,50,000
January 1,2021	$ 1,50,000	0.89286	$ 1,33,929
January 1, 2022	$ 1,50,000	0.7972	$ 1,19,580
January 1, 2023	$ 1,50,000	0.71179	$ 1,06 769
January 1,2024	$ 1,50,000	0.63553	$ 95,330
January 1,2025	$ 1,50,000	0.56744	$ 85,116
December 31,2025	$ 65,500	0.50664	$ 33,185
Total			$ 7,23,908

Since the present value of minimum lease payments are less than fair value of asset 760,000, lessee, should record both lease liability and asset at $723,908.

(ii)

January 1,2020	Right of use asset	$    7,23,908
	Lease liability		$ 7,23,908
	(To record leased asset and lease liability)

(iii)

Since, the lease term is 6 years, lessee should depreciate the asset in 6 years.

December 31,2020	Depreciation (723908/6)	$ 1,20,651
	Right of use asset		$ 1,20,651
	(To record depreciation)

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