On January 1, 2011, the Stridewell Wholesale Shoe Company signed a 25-year non-c

Question

On January 1, 2011, the Stridewell Wholesale Shoe Company signed a 25-year non-cancelable lease agreement for an office building. Terms of the lease call for Stridewell to make annual lease payments of $10,000 at the beginning of each year, with the first payment due on January 1, 2011. Assuming an interest rate of 10% properly reflects the time value of money in this situation, how should Stridewell value the asset acquired and the corresponding lease liability if it is to be treated in a manner similar to an installment purchase? Show journal entries reporting the purchase and interest payments for 2011, 2012 and 2013.

Explanation / Answer

First find the value of the leased asset - Office Bldg Annual lease rental payments are $ 10,000 under a 25 year lease. Assumed financing rate for this lease is 10% and payments are made at the beginning of the year. Since payments are made at the beginning of the year, we will use a present value factor for an annuity due. Remember that many present value tables are based on year-end payments. Step 1: Determine the present value factor to use, 24 years (n-1) and 10% gives us 8.9847 + 1.0000 = 9.9847 present value for annuity due at 10% for 25 years. Step 2: Calculate the present value of cash flows associated with the lease. $ 10,000 x 9.9847 = $ 99,847 Value of Leased Asset.

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