Question

Renewable Co. uses leasing as a secondary means of selling its products. The company contracted with Green Cor-

poration to lease a machine with an economic life of 12 years to be used by Green Corporation in its operations. The

fair value of the asset at the inception of the lease was $400,000; it cost Renewable Co. $360,000 and is carried as

equipment at that value. Payments of $44,925 are to be made by Green Corporation at the beginning of each of the

eight years of the lease. Renewable Co.’s implicit interest rate is 6% per year, which is not known by Green Corpo-

ration. Green Corporation’s incremental borrowing rate is 7%. Renewable Co. estimates the residual value of the

leased asset to be $166,217 at the end of the lease term. The residual value is not guaranteed by Green Corporation.

Renewable Co. will depreciate the equipment on a straight-line basis (assume no salvage value).

Required

a. How would Green Corporation classify the lease?

b. What balances (account titles, amounts) appear on Green’s balance sheet at the end of the first year, related

to the lease?

c. What balances (account titles, amounts) appear on Green’s income statement for the first year, related to the

lease?

Answer 1

Part A

Year	PV factor @ 7%	Remarks
0	1.00000
1	0.93458	= 1 / 1.07
2	0.87344	= 0.93458 / 1.07
3	0.81630	= 0.87344 / 1.07
4	0.76290	= 0.8163 / 1.07
5	0.71299	= 0.7629 / 1.07
6	0.66634	= 0.71299 / 1.07
7	0.62275	= 0.66634 / 1.07
Total	6.38929

Present value (44925*6.38929)	287,039
Divided by: fair value	400,000
Present value criteria percentage	71.76%

	If you meet any criteria of below, then considered as a finance lease, otherwise considered as an operating lease.
Ownership criteria	is ownership transferred to the lessee at the end of lease period?	No
Specialized nature criteria	is leased asset have no special nature and which is no alternative use to the lessor?	No
BPO criteria	is it reasonably certain to exercise of bargain purchase option?	No
Lease term criteria	is the lease period is equal to or more than 75% of the economic life of the leased asset? (8/12=66.67%)	No
Present value criteria	is the present value of payments equal to or more than 90% of the fair value of the leased asset? (71.76%)	No
	Type of Lease	Operating Lease

Part B

Lessee
Lease Amortization Schedule
Date	Annual Lease Payment	Interest on Liability	Reduction of Lease Liability	Lease Liability
Year 1				287,039
Year 1	44,925	0	44,925	242,114
Year 2	44,925	16,948	27,977	214,137

Balance sheet
Assets
Right of use Asset (287039-27977)	259,062
Liabilities
Current liability
Current portion of lease payable [27977 is current portion out of total liability of 242114]	27,977
Non-current liabilities
Lease payable (242114-27977)	214,137

Part C

Income statement
Expenses
Lease expense [Rent expense]	44,925