1. Calculation of the present value of lease payments

$562,907 x 5.32948^ = $3,000,000

(rounded)

^ present value of an annuity due of $1: n=6, i=5%

2. Liability at December 31, 2011

Initial balance, June 30, 2011 $3,000,000

June 30, 2011 reduction (562,907)*

Dec. 31, 2011 reduction (441,052)**

December 31, 2011 net liability $1,996,041

Asset at December 31, 2011

Initial balance, June 30, 2011 $3,000,000

Accumulated depreciation at Dec. 31, 2011 (500,000)**

December 31, 2011 $2,500,000

3. Expenses for year ended December 31, 2011

June 30, 2011 interest expense $ 0*

Dec. 31, 2011 interest expense 121,855**

Interest expense for 2011 $121,855

Depreciation expense for 2011 500,000

Total expenses $621,855

Calculations:

June 30, 2011*

Leased equipment (calculated in req. 1) 3,000,000 Lease payable (calculated in req. 1) 3,000,000 Lease payable 562,907 Cash (lease payment) 562,907

December 31, 2011**

Interest expense (5% x [$3 million – 562,907]) 121,855 Lease payable (difference) 441,052 Cash (lease payment) 562,907

Depreciation expense ($3 million / 3 years x ½ year) 500,000

Accumulated depreciation 500,000

Exercise 15-9

1. Receivable at December 31, 2011

$562,907 x 5.32948^ = $3,000,000

(rounded)

^ present value of an annuity due of $1: n=6, i=5%

Net

Receivable

Initial balance, June 30, 2011 $3,000,000

June 30, 2011 reduction (562,907)*

Dec. 31, 2011 reduction (441,052)**

December 31, 2011 net receivable $1,996,041

The receivable replaces the $3,000,000 machine on the balance sheet.

2. Interest revenue for year ended December 31, 2011

June 30, 2011 interest revenue $ 0*

Dec. 31, 2011 interest revenue 121,855**

Interest revenue for 2011 $121,855

Calculations:

June 30, 2011

Lease receivable (present value calculated above) 3,000,000

Inventory of equipment (lessor’s cost) 3,000,000

Cash (lease payment) 562,907

Lease receivable* 562,907

December 31, 2011

Cash (lease payment) 562,907

Lease receivable (difference)** 441,052 Interest revenue (5% x [$3,000,000 – 562,907]) 121,855

Exercise 15-10

1. Calculation of the present value of lease payments (“selling price”)

$562,907 x 5.32948^ = $3,000,000

(rounded)

^ present value of an annuity due of $1: n=6, i=5%

2. Receivable at December 31, 2011

Receivable

Initial balance, June 30, 2011 $3,000,000

June 30, 2011 reduction (562,907)*

Dec. 31, 2011 reduction (441,052)**

December 31, 2011 receivable $1,996,041

The receivable replaces the $2,500,000 machine on the balance sheet.

3. Income effect for year ended December 31, 2011

June 30, 2011 interest revenue $ 0*

Dec. 31, 2011 interest revenue 121,855**

Interest revenue for 2011 $ 121,855

Sales revenue* 3,000,000

Cost of goods sold* (2,500,000)

Income effect $ 621,855

Calculations:

June 30, 2011*

Lease receivable (present value calculated above) 3,000,000 Cost of goods sold (lessor’s cost) 2,500,000

Sales revenue (present value calculated above) 3,000,000

Inventory of equipment (lessor’s cost) 2,500,000 Cash (lease payment) 562,907

Lease receivable 562,907 December 31, 2011**

Cash (lease payment) 562,907

Lease receivable (difference) 441,052 Interest revenue (5% x [$3,000,000 – 562,907]) 121,855

Exercise 15-11

Requirement 1

a. Transfer of ownership is one of four criteria any of which is sufficient to qualify this as a capital lease.

b. A bargain purchase option is one of four criteria any of which is sufficient to qualify this as a capital lease because, by definition, ownership is expected to transfer.

c. Whether the term of the lease constitutes 75% of the useful life of an asset is one of four criteria any of which is sufficient to qualify this as a capital lease. 70% (14/20) does not meet this criterion.

d. Whether the present value of the minimum lease payments is equal to or greater than 90% of the fair value of the asset is one of four criteria any of which is sufficient to qualify this as a capital lease. 89% (8.9/10) does not meet this criterion.

e. If the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made, that normally would suggest that one of the four classification criteria might be met. But, this, by itself is not a specified criterion under U.S. GAAP for a lease to be classified as a capital lease.

Exercise 15-11 (concluded)

Requirement 2

a. Transfer of ownership normally is an indicator of a finance lease.

b. A bargain purchase option normally is an indicator of a finance lease because, by definition, ownership is expected to transfer.

c. If the term of the lease constitutes a “major portion” of the useful life of an asset a finance lease normally is indicated. Is 70% (14/20) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

d. One situation that normally indicates a finance lease is if the present value of the minimum lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89% (8.9/10) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

e. One situation that normally indicates a finance lease is if the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made. Could another airline use the aircraft without modification or with non-major modification? That information is not specified. With additional information, this is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

Exercise 15-12

Situation 1 (a) $600,000 ÷ 6.53705^** = $91,785 fair lease value payments

^** present value of an annuity due of $1: n=10, i=11%

(b) $91,785 x 6.53705^** = $600,000 (rounded) lease leased asset/ payments lease liability

^** present value of an annuity due of $1: n=10, i=11%

Situation 2 (a) $980,000 ÷ 9.95011^** = $98,491 fair lease value payments

^** present value of an annuity due of $1: n=20, i=9%

(b) $98,491 x 9.95011^** = $980,000 (rounded) lease leased asset/ payments lease liability

^** present value of an annuity due of $1: n=20, i=9%

Situation 3 (a) $185,000 ÷ 3.40183^** = $54,382 fair lease value payments

^** present value of an annuity due of $1: n=4, i=12%

(b) $54,382 x 3.44371^** = $187,276 lease leased asset/ payments lease liability

^** present value of an annuity due of $1: n=4, i=11%

But since this amount exceeds the asset’s fair value, the lessee must capitalize the $185,000 fair value instead.

Exercise 15-13

Situation 1 (a) $600,000 ÷ 5.88923^** = $101,881 fair lease value payments

^** present value of an ordinary annuity of $1: n=10, i=11%

(b) $101,881 x 5.88923^** = $600,000* lease leased asset/ payments lease liability

^* rounded

^** present value of an ordinary annuity of $1: n=10, i=11%

Situation 2 (a) $980,000 ÷ 9.12855^** = $107,355 fair lease value payments

^** present value of an ordinary annuity of $1: n=20, i=9%

(b) $107,355 x 9.12855^** = $980,000^‡ lease leased asset/ payments lease liability

^** present value of an ordinary annuity of $1: n=20, i=9%

^‡ rounded for convenience

Situation 3 (a) $185,000 ÷ 3.03735^** = $60,908 fair lease value payments

^** present value of an ordinary annuity of $1: n=4, i=12%

(b) $60,908 x 3.10245^** = $188,964 lease leased asset/ payments lease liability

^** present value of an ordinary annuity of $1: n=4, i=11%

But since this amount exceeds the asset’s fair value, the lessee must capitalize the $185,000 fair value instead.

Exercise 15-14

Situation 1 Amount to be recovered (fair value) $50,000 ___________________

Lease payments at the beginning 

of each of the next 4 years: ($50,000 ÷ 3.48685^**) $ 14,340

^** present value of an annuity due of $1: n=4, i=10%

Situation 2 Amount to be recovered (fair value) $350,000 Less: Present value of the residual value ($50,000 x .48166^*) (24,083)

Amount to be recovered through periodic lease payments $325,917

_______________________

Lease payments at the beginning 

of each of the next 7 years: ($325,917 ÷ 5.23054^**) $ 62,310

^* present value of $1: n=7, i=11%

^** present value of an annuity due of $1: n=7, i=11%

Exercise 15-14 (concluded)

Situation 3 Amount to be recovered (fair value) $75,000 Less: Present value of the residual value ($7,000 x .64993^*) (4,550)

Amount to be recovered through periodic lease payments $70,450

______________________

Lease payments at the beginning 

of each of the next 5 years: ($70,450 ÷ 4.23972^**) $ 16,617

^* present value of $1: n=5, i=9%

^** present value of an annuity due of $1: n=5, i=9%

Situation 4 Amount to be recovered (fair value) $465,000 Less: Present value of the residual value ($45,000 x .40388^*) (18,175)

Amount to be recovered through periodic lease payments $446,825

______________________

Lease payments at the beginning 

of each of the next 8 years: ($446,825 ÷ 5.56376^**) $ 80,310

^* present value of $1: n=8, i=12%

^** present value of an annuity due of $1: n=8, i=12%

Exercise 15-15

Situation