Question

Lessee computations and entries; finance lease with guaranteed residual value delaney company leases an automobile with a fair value of $10,000 from simon motors Inc., on the following terms.

1. Non-cancelable term of 50 months.
2. Rental of $200 per month (at the beginning of each month). (The present value at 0.5% per month is $8,873.)
3. Delaney guarantees a residual value of $1,180 (the present value at 0.5% per month is $920). Delaney expects the probable
residual value to be $1,180 at the end of the lease term.
4. Estimated economic life of the automobile is 60 months.
5. Delaney's incremental borrowing rate is 6% a year (0.5% a month). Simon's implicit rate is unknown.
instructions
(a) What is the nature of this lease to Delaney?
(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 Delaney'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.
(f) Record the first month's amortization on Delaney's books (assume straight-line).
(g) Suppose that instead of $1,180, Delaney expects the residual value to be only $500 (the guaranteed amount is still
$1,180). How does the calculation of the present value of the lease payments change from part (b)?

Answer 1

The present value of lease payments for the lease liability is $9,793, recorded as both the leased asset and lease liability on Delaney's books at commencement.

(a) Nature of the Lease to Delaney:

The lease to Delaney is a finance lease due to its non-cancelable term and Delaney's guarantee of the residual value.

(b) Present Value of Lease Payments for Lease Liability:

Given:

- Present value of rentals: $8,873

- Present value of guaranteed residual value: $920

Total Present Value = Present Value of Rentals + Present Value of Guaranteed Residual Value

Total Present Value = $8,873 + $920

Total Present Value = $9,793

(c) Recording the Lease on Delaney's Books at Commencement:

Journal Entry:

Leased Asset $9,793

To Lease Liability $9,793

(d) Recording the First Month's Lease Payment:

Journal Entry:

Lease Expense $200

To Cash $200

(e) Recording the Second Month's Lease Payment:

The second month's lease payment of $200 is recorded similarly.

(f) Recording the First Month's Amortization (Straight-line):

Total Lease Liability = Present Value of Lease Payments = $9,793

Monthly Amortization = Total Lease Liability / Number of Months

Monthly Amortization = $9,793 / 50 months

Monthly Amortization ≈ $195.86

(g) Changing the Expected Residual Value to $500:

Recalculating the total present value of lease payments:

Given:

- Present value of rentals: $8,873

- Present value of adjusted guaranteed residual value: $500 (calculated based on the new expected value)

Total Present Value = Present Value of Rentals + Present Value of Adjusted Guaranteed Residual Value

Total Present Value = $8,873 + $500

Total Present Value = $9,373

This updated total present value would be used in place of the previous $9,793 for lease liability calculations.

Answer 2

The present value of the lease payments decreases to $8,354 from $8,873 due to the lower expected residual value

Delaney Company Lease Computations and Entries:

Part (a): Nature of the Lease

Delaney's lease satisfies the criteria for a finance lease as defined by Accounting Standards Codification (ASC) 842.

The lease term is greater than 75% of the economic life of the leased asset (50/60 = 0.83 > 0.75).

The present value of the minimum lease payments is greater than 90% of the fair value of the leased asset ($8,873/$10,000 = 0.8873 > 0.9).

Delaney guarantees a residual value for the asset.

Part (b): Present Value of Lease Payments

The present value of the lease payments is calculated using the lessee's incremental borrowing rate of 0.5% per month:

Present Value (PV) = $200 x [1 - (1 + 0.5%)^(-50)] / 0.5%

PV ≈ $8,873

Part (c): Recording the Lease:

Date: Lease commencement

Journal Entry:

Account Debit Credit

Right-of-Use Asset $8,873

Lease Liability $8,873

Part (d): Recording First Month's Lease Payment:

Date: First month lease payment

Journal Entry:

Account Debit Credit

Lease Expense $200

Prepaid Lease Payments $200

Interest Expense $44.37

Lease Liability $244.37

Step-by-step explanation:

Lease Expense is debited for the monthly lease payment.

Prepaid Lease Payments are credited for the payment in advance.

Interest Expense is calculated on the outstanding lease liability ($8,873) at the lessee's incremental borrowing rate (0.5%) and debited.

Lease Liability is credited for the amount paid and the interest expense.

Part (e): Recording Second Month's Lease Payment:

Date: Second month lease payment

Journal Entry:

Account Debit Credit

Lease Expense $200

Prepaid Lease Payments $200

Interest Expense $42.19

Lease Liability $242.19

Step-by-step explanation:

Similar to the first month's payment, but the remaining lease liability is now $8,628.73 ($8,873 - $244.37).

Part (f): Recording First Month's Amortization:

Date: End of first month

Journal Entry:

Account Debit Credit

Depreciation Expense $146.67

Accumulated Depreciation - Right-of-Use Asset $146.67

Step-by-step explanation:

Depreciation is calculated on a straight-line basis over the lease term (50 months) and the economic life of the asset (60 months), whichever is shorter. In this case, the shorter period is 50 months.

Part (g): Change in Residual Value:

If Delaney expects the residual value to be $500 instead of $1,180, the present value of the lease payments will change.

Revised Calculation:

Present Value (PV) = $200 x [1 - (1 + 0.5%)^(-50)] / 0.5% + $500 / (1 + 0.5%)^50

PV ≈ $8,354

The present value of the lease payments decreases to $8,354 from $8,873 due to the lower expected residual value