Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $31,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $234,000 (its fair value) and was expected to have a useful life of 13 years with no salvage value at the end of its life. (Because the lease term is only 9 years, the asset does have an expected residual value at the end of the lease term of $68,243.) Crescent seeks a 9% return on its lease investments. By this arrangement, the lease is deemed to be an operating lease.

1. What will be the effect of the lease on Café Med’s earnings for the first year (ignore taxes)?

2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Café Med (ignore taxes)

Answer 1

Solution 1
Right to use assets
Annual lease payment	31000
*cumulative PV factor for annuity due at 9% for 9 periods	6.534819
Right to use assets	202579
Interest expesne [(202579-31000)*9%]	-15442
Amortization for the year (31000- Interest expense)	-15558
Effect on earnings for first year	-31000

Solution 2:
Lease payable balance (End of year)
beginning balance	202579
Add: Interest expense	15442
less: Payments (annual payment *2)	62000
Lease payable balance (end of year)	156021
Right of use asset balance (end of year)
beginning balance	202579
Less: Amortization	15558
Right of use asset balance (end of year)	187021