Hox Co. &Owl; Co. sign a s-year lease requuring that Owl pay $97,500 annual paym

Question

Hox Co. &Owl; Co. sign a s-year lease requuring that Owl pay $97,500 annual payments to Fox. The lease term and 1st annual payment begins 1/1/18. Owl pays the insurance and any maintenance costs to 3rd parties, but also pays a $4,500 annual property tax that is included in each lease payment. Fox paid $442,500 to buy the equipment immediately before signing the lease, estimates its useful life is 7 years with no residual value, and used an implicit rate of 9% to determine annual payments. If Owl had decided to get a loan to buy the equipment, the borrowing rate would be at 8%. Present values $401,025 using 8%, both rates known to Owl Owl uses only lease and it contains a bargain purchase option, what is Ow's of the minimum lease payments using 9% is $394,290, and straight-line for book depreciation. Assuming this is a capital 2021 lease depreciation expense?

Explanation / Answer

Lease depreciation expense is calculated as follows:

Net Capitalized cost- Residual value

Useful life of the asset

Net Capitalized cost for owl (assume discounting rate = 9%) would be equal to prsesnt value of minimum lease payments = $394290

Depreciation expense for 2021 (if discounting rate = 9%) = 394290/7 = $56327

In case the equipment is borrowed at 8% then the Net Capitalized cost for owl would be equal to present value of minimum lease payments = $401025 and in that case, depreciation expense for 2021 would be calculated as follows:

401025/7 = $57289

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