Question

On December 31, 2017, Day Company leased a new machine from Parr with the following pertinent information:

Lease term	5 years
Annual rental payable on December 31 (beginning December 31, 2017)	$50,000
Useful life of machine	8 years
Day's incremental borrowing rate	15%
Implicit interest rate in lease (known by Day)	11%

The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $375,500. Day early adopted ASU 2016-02.

1. Explain whether the lease will be an operating lease or a finance lease under ASU 2016-02

2. Compute the amount of Day's lease liability at the beginning of the lease term under ASU 2016-02 assuming that the first payment has been made.

Answer 1

Day Company
A lease is a capital lease if its term is 75% or more of the life of leased property.The rate to
use to calculate present value is the lessor's implicit rate if known by the lessee and if it is
lower than the lessee's incremental borrowing rate :
Lease term 5 years = 62.5% and is a operating lease
Life of machine = 8 years
Lease payment x PV factor at 11%      =				PV of lease
50000                    x		4.1024	=	205120