Question

On January 1, 2018, Majestic Mantles leased a lathe from Equipment Leasing under a finance lease. Lease payments are made annually. Title does not transfer to the lessee and there is no purchase option or guarantee of a residual value by Majestic. Portions of the Equipment Leasing’s lease amortization schedule appear below:

Jan. 1	Payments		Effective Interest		Decrease in Balance		Outstanding Balance
							210,711
2018	22,500				22,500		188,211
2018	22,500		18,821		3,679		184,532
2019	22,500		18,453		4,047		180,485
2020	22,500		18,049		4,451		176,034
2021	22,500		17,603		4,897		171,137
2022	22,500		17,114		5,386		165,751
2023	22,500		16,575		5,925		159,826
—	—		—		—		—
—	—		—		—		—
—	—		—		—		—
2035	22,500		5,596		16,904		39,051
2036	22,500		3,905		18,595		20,456
2037	22,500		2,046		20,456		0

Required:

1. What is Majestic’s lease liability at the beginning of the lease (after the first payment)?
2. What amount would Majestic record as a right-of-use asset?
3. What is the lease term in years?
4. What is the effective annual interest rate? (Round your percentage answers to 1 decimal place.)
5. What is the total amount of lease payments?
6. What is the total effective interest expense recorded over the term of the lease?

Answer 1

Solution 1:

Majestic’s lease liability at the beginning of the lease = $188,211

Solution 2:

Amouat would Majestic record as a right-of-use asset = Present value of minimum lease payments = $210,711

Solution 3:

Lease term in years = 2018 to 2037 = 20 years

Solution 4:

Effective annual interest rate = $18,821/ $188,211 = 10%

Solution 5:

Total amount of lease payments = 22500*20 = $450,000

Solution 6:

Total effective interest expense recorded over the term of the lease = Total lease payments - Right to use asset recorded at beginning of period

= $450,000 - $210,711 = $239,289