Question

Packard Dairy leases its milking equipment from Patterson Finance under the following lease terms: The lease...

Packard Dairy leases its milking equipment from Patterson Finance under the following lease terms:

The lease term is 10 years, noncancelable, and requires equal rental payments due at the beginning of each year starting January 1, 2007.

The equipment has a fair value and cost at the inception of the lease (January 1, 2007) of $195,078, and estimated economic life of 10 years, and a residual value (which is guaranteed by Packard Dairy) of $15,000.

The lease contains no renewable options and the equipment reverts to Patterson Finance upon termination of the lease.

Packard’s incremental borrowing rate is 8% per year. Patterson’s implicit rate of 9% is unknown to Packard.

Packard and Patterson depreciate similar equipment using the straight-line method.

Collectibility of the payments are not reasonably assured and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

What is the depreciation expense of Packard for the year ended December 31, 2007?

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Answer #1

Depreciation Expense in the books of (Lessee) Packard for December 31st,2007:

Fair Value and cost at the inception of lease = $195078

Estimated Economic Life = 10 years

Lease term = 10 years

Residual Value = $15000

As, lease term and economic life is equal to 10 years , it is a finance lease.

Asset to be recognized in the books of Packard = Lower of a) Fair Value b) Minimum Lease Payments

= $195078

Rate of Depreciation p.a = 100/10 yrs = 10%

Depreciation Expense of Packard for the year ended Dec 31st , 2007 = ($195078-$15000)*10% = $18008

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