On January 1, 2015, Day Corp. entered into a 10-year lease agreement with Ward,

Question

On January 1, 2015, Day Corp. entered into a 10-year lease agreement with Ward, Inc. for industrial equipment. Annual lease payments of $10,000 are payable at the end of each year. Day knows that the lessor expects a 10 percent return on the lease. Day has a 12 percent incremental borrowing rate. The equipment is expected to have an estimated useful life of 10 years. In addition, a third party has guaranteed to pay Ward a residual value of $5,000 at the end of the lease The present value of an ordinary annuity of $1 at 12% for 10 years is 5.6502 10% for 10 years is 6.1446 12% for 10 years is 0.3220 10% for 10 years is 0.3855 The present value of $1 at On Day's October 31, 2015, balance sheet, the principal amount of the lease obligation was $58,112 $63,374 $61,446 $56,502.

Explanation / Answer

Ans.c

The principal amount of the lease obligation on the date indicated in the question is the same as at the inception of the lease because no lease payment has been made as of the balance sheet date. The lessee uses the lower of the implicit return to the lessor (10%) and its incremental borrowing rate(12%). The third-party guarantee does not affect the lessee. Therefore, the principal amount is 6.1446x $10,000 = $61,446

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