Question

Montana Inc. sells computer systems. Montana leases computers to Utah Company on June 30 , 20 1 7 . The computers cost Montana $ 12 million to manufacture . Th e lease is non - cancelable and ha s the following terms:

• Lease payments: $2,466,754 semiannually; first payment due J une 30 , 20 1 7 ; remaining payments due December 3 1 and J une 30 each year through December 31 , 20 2 1.

• Lease term: 5 years (10 semi - annual payments) .

• No residual value; no bargain purchase option .

• Economic life of equipment: 5 years .

• Implicit interest rate and lessee's incremental borrowing rate: 10% per year .

• Fair value of the computers at J une 30 , 201 7 : $20 million .

Collect a bility of the rental payments is reasonably assured, and there are no lessor costs yet to be incurred.

_____ 1 0 . Montana would account for this lease as:

A) A finance lease.

B) A sales type lease without selling profit .

C) A sales type lease with selling profit .

D) An operating lease .

_____ 1 1 . Utah Company would account for this lease as:

A) A finance lease.

B) A sales type lease without selling profit .

C) A sales type lease with selling profit .

D) An operating lease.

_____ 1 2 . T he net carrying value of the lease liability on Utah 's books after the December 31 , 20 1 7 payment is closest to:

A) $ 15,943,154

B) $ 17,533,246

C) $21,000,000

D) $15,066,492

_____ 1 3 . Total interest revenue Montana would report on its year end December 31, 20 1 7 income statement relative to this lease is closest to:

A) $ 4,933,508

B) $1,673,820

C) $876, 66 2

D) $2,466,754   

Answer 1

10) In the given case, the lessor (i.e. Montana Inc.) deals in computer systems (i.e. it is their operating activity). The fair value of lease is $20 million and cost to manufacture for the computer is $12 million. The lease term is for the whole life of computer (i.e. 5 years) and there is no residual value and bargain option at the end of the lease period. Therefore the given lease will be accounted by Montana (i.e. the lessor) as a sales type lease with selling profit. Therefore the correct answer is C) Sales type lease with selling profit.

11) As the economic life and lease term of computer is equal (i.e. 5 years), the lease will be accounted as finance lease by Utah Company (i.e. the lessee). Therefore the correct answer is A) A finance lease.

12) The net carrying value of lease liability on Utah's books is calculated as follows:-

Step 1
Fair Value on June 30, 2017	20,000,000
Less: Lease payment of June 30, 2017	(2,466,754)
Carrying Value on June 30, 2017	17,533,246
Interest on Dec 31, 2017 ($17,533,246*10%*6/12)	876,662
Step 2
Second Lease Payment	2,466,754
Less: Interest	(876,662)
Reduction of Lease Liability	1,590,092
Step 3
Lease Laibility on June 30, 2017	17,533,246
Less: Reduction of Lease Liability	(1,590,092)
Lease Liability on Dec 31, 2017	15,943,154

Therefore the lease liability on Utah 's books after the December 31 , 2017 payment is closest to $15,943,154. Hence the correct option is A) $15,943,154.

13) Interest Revenue that will be reported on Dec 31, 2017 balance Sheet will be $876,662 (as calculated in step 1 of Question 12). Therefore the correct option is C) $876,662.