Question

King Company leased equipment from Mann Industries. The lease agreement qualifies as a finance lease and requires annual lease payments of $52,538 over a six-year lease term (also the asset's useful life), with the first payment at January 1, the beginning of the lease. The interest rate is 5%. The asset being leased cost Mann $230,000 to produce.

1. Determine the price at which the lessor is "selling the asset (present value of the lease payments).
2. What would be the amounts related to the lease that the lessor would report in its income statement for the year ended December 312(Ignore taxes)?

Answer 1

1. The price at which the lessor is "selling the asset is $280,000.05.

2. These are the following:

Sales revenue = $280,000.05

Cost of goods sold = $230,000

Interest revenue = $11,373.10

Step-by-step explanation:

1. Determine the price at which the lessor is "selling the asset (present value of the lease payments).

Since the first payment is at the beginning of the lease, this can be determined using the formula for calculating the present value of an annuity due as follows:

PV = P * ((1 - (1 / (1 + r))^n) / r) * (1 + r) …………………………………. (1)

Where;

PV = Present value of the lease payments or the price at which the lessor is "selling the asset = ?

P = Annual lease payments = $52,538

r = Interest rate = 5%, or 0.05

n = number of years of the lease term = 6

Substitute the values into equation (1), we have:

PV = $52,538 * ((1 - (1 / (1 + 0.05))^6) / 0.05) * (1 + 0.05)

PV = $280,000.05

Therefore, the price at which the lessor is selling the asset is $280,000.05.

2. What would be the amounts related to the lease that the lessor would report in its income statement for the year ended December 312(Ignore taxes)?

These are the following:

Sales revenue = The price at which the lessor is selling the asset = $280,000.05

Cost of goods sold = $230,000

Interest revenue = (Sales revenue - First annual lease payments) * Interest rate = ($280,000.05 - $52,538) * 5% = $11,373.10