Question

On January 2, 2020, Micheal (lessee) entered into a 10-year non-cancelable lease with Thomas (lessor) for equipment. The following facts relate to the transaction:

-The equipment has an estimated useful life of 13 years.
-There is no purchase option. Transfer of ownership to Michael is not stipulated in the lease contract.
-The fair value to Thomas (lessor) at the inception of the lease was $4,000,000. Lessor's cost was $3,775,000. Sales
commissions were $2,500.
-Michael's incremental borrowing rate is 10%. The implicit annual rate in the lease (known to Michael) is 8%.
- Michael and Thomas use straight-line depreciation.
-The lease requires rental payments of $266,000, payable on 1/2/20 and subsequently on 6/30 and 12/31.
-Michael guarantees that Thomas will realize $200,000 from selling the asset at the end of the lease. The expected residual value is $120,000.

1. Refer to the original facts but also assume that Micheal had the option to buy the asset on 12/31/2022 for $2,000,000. It is reasonably certain that Micheal would exercise the purchase option. Discuss at what amount Micheal should record the ROU Asset on January 2, 2020 and what the ROU amortization for 2020 would be.

Given Tip: 266,000 (P₅,4% +1.00) +2,000,000 (p₆,4%) = ROU Asset ROU Asset amortization based on criteria # 2

Please show all work! I will thumbs up your answer!

Answer 1