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Pat Delaney Company leases an automobile with a fair value of $13,628 from John Simon Motors, Inc., on the following terms.
| 1. | Noncancelable term of 55 months. | |
| 2. | Rental of $290 per month (at end of each month). (The present value at 1% per month is $12,223.) | |
| 3. | Estimated residual value after 55 months is $1,160. (The present value at 1% per month is $671.) Delaney Company guarantees the residual value of $1,160. | |
| 4. | Estimated economic life of the automobile is 60 months. | |
| 5. | Delaney Company’s incremental borrowing rate is 12% a year (1% a month). Simon’s implicit rate is unknown. |
What is the present value of the minimum lease payments?
Record the lease on Delaney Company’s books at the date of inception.
Record the first month’s depreciation on Delaney Company’s books (assume straight-line).
Record the first month’s lease payment.
Expert Answer
Present Value of Minimum Lease Payments:
The minimum lease payments in the case of guaranteed residual value (GRV) by the lessee includes the guaranteed residual value also, apart from the lease payments.
Present value of Monthly rental of $290 per month for 55 months (given) = $12,223
Present value of residual value of $1,160 guaranteed by lessee = $671
Present value of minimum lease payment = ($12,223 + $671) = $12,894
Record the lease on Delaney Company’s books at the date of inception:
| At the date of Inception | Leased Equipment | $12,894 | |
| Lease Liability | $12,894 | ||
Record the first month’s depreciation on Delaney Company’s books (assume straight-line):
Amount of Depreciation expense = ($12,894 – $1,160) / 55 months = $213.35
| First month’s Depreciation | Depreciation Expenses | $213.35 | |
| Accumulated Depre. – Capital | $213.35 | ||
Record the first month’s lease payment:
| Lease Payment | Lease Liability** | $161.06 | |
| Interest Expenses* | $128.94 | ||
| Cash | $290 |
* Interest Expense = 1% of $12,894
** Lease liability = Balancing figure ($290 – $128.94)
