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?
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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