1. ABC Co. (lessee) signs a lease agreement on July 1st, 2018 to lease equipment
ID: 2517078 • Letter: 1
Question
1. ABC Co. (lessee) signs a lease agreement on July 1st, 2018 to lease equipment from Daly Leasing Company (lessor). The following data relates to this lease agreement: () The term of the non-cancelable lease is 4 years, with no renewal option. The asset will return to the lessor at the end of a lease term. (2) Payments of 195,989 are due on July 1st of each year. The first payment is made at the inception of this lease. This payment includes $300 for propery tax (executory costs). (3) The fair value of the equipment on July 1st, 2018 is $700,000. The useful economic life of this equipment is 6 years, with no salvage value. (4) ABC's incremental borrowing rate is 8% per year. The implicit rate used by Daly Leasing Company in computing the lease payments is 8%. (6) Collectbility of the payments is reasonably predictable, and there are no important uncertainties surrouding the costs yet ot be incurred by the lessor. Required: (a) Indicate the type of lease ABC has entered into and if individual criteria are met. You need to include your present value calculatoin for miminum lease payments.Explanation / Answer
Answer:
Lease term 4 years.
Fair value at inception date = $700,000
Implicit rate used = 8%
Lease payments are $195,989 on July 1st each year with first payment made at the inception of the lease. The lease payment includes $300 for property tax.
Lease payment net of property tax = $195,989 - $300 = $195,689
Present Value Interest Factors for a One-Dollar Annuity Discounted at 8% for 3 Periods = 2.5771
Hence present value for minimum lease payments = $195,689 + $195,689 * 2.5771 = $699,999
The present value for minimum lease payments is almost equal to fair value.
Hence it meets the criteria # 4 which states that to classify a lease to be a capital lease the present value at the beginning of the lease term of the minimum lease payments has to be equal to or more than 90 percent of its fair value.
The classification of this lease is 'Capital lease'.
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