Question

Which of the following transactions would require the use of the present value of an annuity due concept in order to calculate the present value of the asset obtained or liability owed at the date of incurrence?

a. A capital lease is entered into with the initial lease payment due upon the signing of the lease agreement.
b. A capital lease is entered into with the initial lease payment due one month subse-quent to the signing of the lease agreement.
c. A ten-year 8% bond is issued on January 2 with interest payable semiannually on July 1 and January 1 yielding 7%.
d. A ten-year 8% bond is issued on January 2 with interest payable semiannually on July 1 and January 1 yielding 9%

Answer 1

a. A Capital lease is entered into with the initial lease payment due upon the signing of the lease agreement

Step-by-step explanation:

Annuity due concept is used for the payment schedule whereby regular payments are made/received at the beginning of the period say, at the beginning of a month or at the beginning of the year.

The present value computed using the annuity due concept is more than the present value computed under deferred annuity wherein payments are made at the end of the period.

Under a capital lease, the lessor is only responsible for financing the asset whereas all other risks and rewards and ownership rest with the lessee.

A capital lease wherein the initial lease payment falls due at the time of signing of the agreement would use the present value of annuity due concept.