Each of the three independent situations below describes a capital lease in whic

ID: 2477738 • Letter: E

Question

Each of the three independent situations below describes a capital lease in which annual lease payments are payable at the beginning of each year. The lessee is aware of the lessor’s implicit rate of return. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Determine the amount of the annual lease payments as calculated by the lessor and the amount the lessee would record as a leased asset/liability, for above situations.

Situation 1 2 3 Lease term (years) 11 21 5 Lessor’s rate of return (known by lessee) 11% 9% 12% Lessee’s incremental borrowing rate 12% 10% 11% Fair value of leased asset $670,000 $1,050,000 $255,000

Explanation / Answer

Answer:

Situation

PVAD(i,n years) for Lessor i.e present value factor with lessor’s rate of return.

6.88923

10.12855

4.03735

Therefore anuual lease payments is equal to fair value of asset leased divided by PVAD of lessor

$97,253.25

$103,667.36

$63,160.24

PVAD(i,n years) of lessee i.e present value factor at lesse’s rate of return.

6.65022

9.51356

4.10245

Amount of Asset to be recorded by Lessee = PVAD of Lessee * Annual lease payments

$646,755.50

$986,245.61

$259,111.73

Please note the rate of return of lessor would be used to calculate lease payments but incremental rate of borrowing would be used to calculate asset/liability to be recorded for leased asset.