Question

Trident Architects, LP leases an automobile with a fair value of $32,000 from Hub City Motors, Inc., on the following terms: 1. Non-cancelable term of 48 months. 2. Rental of $600 per month (at the beginning of each month). (The present value at 0.5% per month is $25,676.) 3. Trident guarantees a residual value of $7,000 (the present value at 0.5% per month is $5,510). Trident expects the probable residual value to be $7,000 at the end of the lease term. 4. Estimated economic life of the automobile is 60 months. 5. Trident's incremental borrowing rate is 6% a year (0.5% a month). Hub City's implicit rate is unknown. Instructions (Round all numbers to the nearest dollar.) (a) What is the nature of this lease to Trident? (b) What is the present value of the lease payments to determine the lease liability? (c) Based on the original fact pattern, record the lease on Trident's books at the date of commencement. (d) Record the first month's lease payment (at commencement of the lease). (e) Record the second month's lease payment. (g) Suppose that instead of $7,000, Trident expects the residual value to be only $4,000 (the guaranteed amount is still $7,000). How does the calculation of the present value of the lease payments change from part (b)?

Answer 1

The lease for Trident is a finance lease, and the present value of the lease liability is $31,186. The accounting for the lease involves debiting an asset account and crediting a liability account for the lease's present value. The expected change in the residual value does not affect the present value calculation as long as the guarantee remains unchanged.

Step-by-step explanation:

The nature of the lease for Trident is likely a finance lease because it includes a guarantee for a residual value, has a term for a significant portion of the economic life of the asset, and the present value of lease payments amounts to a substantial part of the fair value of the automobile.

To calculate the present value for the lease liability, we need to add the present value of the monthly payments and the present value of the guaranteed residual value. Using the information provided, the present value of the lease payments is $25,676, and the present value of the guaranteed residual value is $5,510, resulting in a total present value of $31,186.

For the recordation of the lease and monthly lease payments on Trident's books, we would debit an asset account and credit a liability account for the present value of the lease at the commencement. Then, at each lease payment, we would debit the liability and interest expense while crediting the cash/bank account for the payment amount.

If the expected residual value changes to $4,000, the calculation of the present value of the lease payments would not change from part (b) because the guarantee remains at $7,000, which is the amount used in the present value calculation.