Question

At January 1, 2024, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement.

• The lease agreement specifies annual payments of $27,000 beginning January 1, 2024, the beginning of the lease, and on each December 31 there after through 2031.
• The equipment was acquired recently by Crescent at a cost of $198,000 (its fair value) and was expected to have a useful life of 13 years with no salvage value at the end of its life. Crescent records depreciation using the straight-line method.
• Because the lease term is only nine years, the asset does have an expected residual value at the end of the lease term of $46,826.
• Crescent seeks a 9% return on its lease investments.
Required:
1. What will be the effects of the lease on Crescent's (lessor's) earnings for the first year (ignore taxes)?
2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Crescent (ignore taxes)?

Answer 1

Crescent's earnings in the first year of the lease will be $14,466.62. At the end of the first year, Crescent's balance sheet will show a lease liability of $169,284.23 and accumulated depreciation of $12,533.38.

Step-by-step explanation:

1. In the first year, Crescent's earnings from the lease would be the total annual payment of $27,000 minus the depreciation expense for the first year. The asset has a useful life of 13 years and no salvage value, so the annual depreciation expense would be ($198,000 - $46,826) / 13 = $12,533.38. Therefore, Crescent's earnings in the first year would be $27,000 - $12,533.38 = $14,466.62.

2. At the end of the first year, Crescent's balance sheet accounts related to the lease would show the remaining lease liability and the accumulated depreciation. The lease liability at the end of the first year would be the remaining lease payments for the remaining 8 years, discounted at a 9% rate. The present value of the remaining lease payments would be $27,000 * (1 - (1 + 9%)^-8) / 9% = $169,284.23. The accumulated depreciation at the end of the first year would be the depreciation expense for the first year, which is $12,533.38. Therefore, Crescent's balances sheet accounts related to the lease would show a lease liability of $169,284.23 and accumulated depreciation of $12,533.38.