Question

On June 30, 2021, Georgia-Atlantic, Inc. leased warehouse equipment from Builders, Inc. The lease agreement calls for Georgia-Atlantic to make semiannual lease payments of $880,440 over a 3-year lease term (also the asset’s useful life), payable each June 30 and December 31, with the first payment at June 30, 2021. Georgia-Atlantic's incremental borrowing rate is 8.0%, the same rate Builders used to calculate lease payment amounts. Builders manufactured the equipment at a cost of $4.3 million.

Required:
1. Determine the price at which Builders is "selling" the equipment (present value of the lease payments) at June 30, 2021.
2. What amount related to the lease would Builders report in its balance sheet at December 31, 2021 (ignore taxes)?
3. What line item amounts related to the lease would Builders report in its income statement for the year ended December 31, 2021 (ignore taxes)?

Answer 1

a. No. of periods = 3 years * 2 = 6 semiannual periods

Interest = 8% / 2 = 4% per seminannual period

Payment was first made on the same day so this is an annuity due.

Present value of lease :

= Amount * Present value interest factor of annuity due, 6 periods, 4%

= 880,440 * 5.4518

= $4,799,983

b. Amount in balance sheet:

= Amount of liability remaining end of June + interest - lease payment received end of December

Amount of liability remaining end of June = 4,799,983 - 880,440

= $‭3,919,543‬

Interest = ‭3,919,543‬ * 4% = $‭156,782

= 3,919,543 + 156,782 - 880,440

= $‭3,195,885‬

c. Interest revenue in Income statement = $156,782

Pretax revenue reported in income statement = $4,799,983

Pretax COGS reported in income statement = $4,300,000 for manufacturing the equipment.

Pretax amount for lease:

= Revenue - COGS + Interest revenue

= 4,799,983 - 4,300,000 + 156,782

= $‭656,765‬