Question 6 Eubank Company, as lessee, enters into a lease agreement on July 1, 2

Question

Question 6

Eubank Company, as lessee, enters into a lease agreement on July 1, 2014, for equipment. The following data are relevant to the lease agreement: The term of the noncancelable lease is 3 years, with no renewal option. Payments of $784,100 are due on July 1 of each year. The fair value of the equipment on July 1, 2014 is $2,163,418. The equipment has an economic life of 6 years with no salvage value. Eubank depreciates similar machinery it owns on the sum-of-the-years'-digits basis. The lessee pays all executory costs. Eubank's incremental borrowing rate is 11% per year. The lessee is aware that the lessor used an implicit rate of 9% in Computing the lease payments (present value factor for 3 periods at 9%, 2.75911; at 11%, 2.71252.

Explanation / Answer

1)

Capital Lease Method

Note :

Capitalised Amount = Lease Payment* PVA(11%,3)

Capitalised Amount = 784100*2.75911

Capitalised Amount = $ 2163418

Since Capitalised Amount is equal to Fair value, the lease should be considered as Capital Lease

2)

Lease Amortisation Statement Date Annual Lease Payment Interest on Unpaid Liability Reduction of Lease Liability Balance of Lease Liability 1/7/14 1379318 1/7/15 784100 151725 632375 746943 1/7/16 784100 82164 701936 45007

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