Question

At January 1, 2018, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $27,000 beginning January 1, 2018, the beginning of the lease, and at each December 31 thereafter through 2025. The equipment was acquired recently by Crescent at a cost of $198,000 (its fair value) and was expected to have a useful life of 13 years with no salvage value at the end of its life. (Because the lease term is only 9 years, the asset does have an expected residual value at the end of the lease term of $46,826.) Crescent seeks a 9% return on its lease investments. By this arrangement, the lease is deemed to be an operating lease. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
  
Required:
1. What will be the effect of the lease on Crescent’s (lessor’s) earnings for the first year? (Enter decreases with negative numbers.)
2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Crescent?

1	Effect on earnings
2	Equipment balance (net, end of year)
	Deferred lease revenue

Answer 1

Solution 1:

Crescent will recognized rental revenue of $27,000 each year for operating lease agreement.

Further depreciation to be charged by Crescent on equipment acquired.

Annual depreciation = Cost of equipment / Useful life = $198,000 / 13 = $15,231

Effect on earnings of Crescent = Rental revenue - Depreciation expense = $27,000 - $15,231 = $11,769

Solution 2:

Equipment balance (net) at the end of 2018 = Cost - Accumulated depreciation = $198,000 - $15,231 = $182,769

Deferred lease revenue = Rental received in advance on 31.12.2018 for 2019 year = $27,000