Question

# Sage Hill Company leases an automobile with a fair value of \$12,257 from John Simon Motors,...

Sage Hill Company leases an automobile with a fair value of \$12,257 from John Simon Motors, Inc., on the following terms:

1. Non-cancelable term of 50 months.
2. Rental of \$250 per month (at the beginning of each month). (The present value at 0.5% per month is \$11,091.)
3. Sage Hill guarantees a residual value of \$1,190 (the present value at 0.5% per month is \$927). Delaney expects the probable residual value to be \$1,190 at the end of the lease term.
4. Estimated economic life of the automobile is 60 months.
.

5. Sage Hill’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown.

 What is the nature of this lease to Sage Hill? (financing or operating) What is the present value of the lease payments to determine the lease liability? Based on the original fact pattern, record the lease on Sage Hill’s books at the date of commencement. Record the first month’s lease payment (at commencement of the lease). Record the second month’s lease payment. Record the first month’s amortization on Sage Hill’s books (assume straight-line). Suppose that instead of \$1,190, Sage Hill expects the residual value to be only \$500 (the guaranteed amount is still \$1,190). How does the calculation of the present value of the lease payments change from part (b)?

 1. Financing
 2. present value of the minimum lease payments = pv of rental income + pv of residual amount
 =\$11091+\$927.=\$12018
 3. Amount of asset to be recognised = lower of present value of the minimum lease payments or fair value
 = \$12018
 Journal Entry S. No. Account title & Explanation Debit Credit 4) Machinery A/c 12018 John Simon Motor Co. 12018 (being lease recognised at the inception) 5) Depreciation A/c 200.3 Machinery A/c (12018/60) 200.3 To Recognized Depreciation 6) Interest A/c (12018*1%) 120.18 John Simon Motore Inc. (\$250-120.18) 129.82 Bank A/c 250 (being 1st month lease payment made)

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