Question

At January 1, 2018, Cafe Med leased restaurant equipment from Crescent Corporation under a nice-year lease agreement. The lease agreement specifies annual payments of $34,000 beginning January 1, 2018, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was aquired recently by Crescent at a cost of $261,000 (its fair value) and was expected to have a useful life of 12 years with no salvage value at the end of its life. (Because the lease term is only 9 terms, the asset does have an expected residual value at the end of the lease term of $63,196). Crescent seeks a 8% return on its lease investments. By this arrangement, the lease is deemed to be an operating issue. LOOKING FOR NUMERIC ANSWERS FOR BOTH QUESTIONS!!!

1) What will be the effect on the lease of Cafe Med's earnings for the first year (ignore taxes)? (NUMBER ANSWER NOT AN EXPLANATION)

2) What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Cafe Med (ignore taxes)? a) Lease payable balance (end of year)? b) Right of use asset balance (end of year)?

Answer 1

Solution 1:

Right to use assets = Present value of lease payments

= $234,000 * cumulative PV factor for annuity due at 8% for 9 periods

= $34,000 * 6.746639 = $229,386

Interest expense for first year = ($229,386 - $34,000) * 8% = $15,631

Amortization for the year = $34,000 - $15,631 = $18,369

Effect on earnings for first year = Interest expense + Amortization expense = -$15,631 - $18,369 = ($34,000)

Solution 2:

Lease payable balance (End of year) = beginning balance + Interest expense - Payments

= $229,386 + $15,631 - $34,000 - $34,000 = $177,017

Right of use asset balance (end of year) = Begininnig balance - Amortization

= $229,386 - $18,369 = $211,017