1. Effective rate of interest implicit in the agreement

$6,074,700 ÷ $2,000,000 = 3.03735 present lease present value value payment table amount

This is the ordinary annuity present value table amount for n = 4, i = ? In row 4 of the present value table, the number 3.03735 is in the 12% column. So, 12% is the implicit interest rate.

2. Inception of the lease

Leased asset(fair value) 6,074,700 Lease payable (present value) 6,074,700

3. December 31, 2011

Interest expense(12% x $6,074,700) 728,964 Lease payable (difference) 1,271,036 Cash(lease payment) 2,000,000

4. December 31, 2012

Interest expense(12% x [$6,074,700 – 1,271,036]) 576,440 Lease payable (difference) 1,423,560 Cash(lease payment) 2,000,000

5. Inception of the lease

$2,000,000 x 3.10245^** = $6,204,900 lease present payment value

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

Leased asset 6,204,900 Lease payable 6,204,900

Problem 15-5

1. Calculation of the present value of lease payments

$391,548 x 15.32380^ = $6,000,000

(rounded)

^ present value of an annuity due of $1: n=20, i=3%

2. Liability at December 31, 2011

Initial balance, September 30, 2011 $6,000,000

Sept. 30, 2011 reduction (391,548)*

Dec. 31, 2011 reduction (223,294)**

December 31, 2011 net liability $5,385,158

The current and noncurrent portions of the liability would be reported separately.

Asset at December 31, 2011

Initial balance, September 30, 2011 $6,000,000

Accumulated depreciation at Dec. 31, 2011 (300,000)**

December 31, 2011 $5,700,000

3. Expenses for year ended December 31, 2011

Sept. 30, 2011 interest expense $ 0*

Dec. 31, 2011 interest expense 168,254**

Interest expense for 2011 $168,254

Depreciation expense for 2011 300,000

Total expenses $468,254

Problem 15-5 (concluded)

4. Statement of cash flows for year ended December 31, 2011

Werner would report the $6,000,000* investment in the protein analyzer and its financing with a capital lease as a significant noncash investing and financing activity in the disclosure notes to the financial statements.

The $783,096 ($391,548 x 2) cash lease payments are divided into the interest portion and the principal portion. The interest portion, $168,254**, is reported as cash outflows from operating activities. The principal portion, $391,548 + $223,294**, is reported as cash outflows from financing activities.

Note: By the indirect method of reporting cash flows from operating activities, we would add back to net income the $300,000 depreciation expense since it didn’t actually reduce cash. The $168,254 interest expense that reduced net income actually did reduce cash [the interest portion of the $783,096 ($391,548 x 2) cash lease payments], so for it, no adjustment to net income is necessary.

Calculations:

September 30, 2011*

Leased equipment (calculated in req. 1) 6,000,000 Lease payable (calculated in req. 1) 6,000,000 Lease payable 391,548 Cash (lease payment) 391,548

December 31, 2011**

Interest expense (3% x [$6 million – 391,548]) 168,254 Lease payable (difference) 223,294 Cash (lease payment) 391,548

Depreciation expense ($6 million / 5 years x ¼ year) 300,000

Accumulated depreciation 300,000

Problem 15-6