On January 1, 2021, Pharoah, Inc. signs a 10-year noncancelable
lease agreement to lease a storage building from Holt Warehouse
Company. Collectibility of lease payments is reasonably predictable
and no important uncertainties surround the amount of costs yet to
be incurred by the lessor. The following information pertains to
this lease agreement.
(a) The agreement requires equal rental payments at the beginning each year.
(b) The fair value of the building on January 1, 2021 is $5600000; however, the book value to Holt is $4550000.
(c) The building has an estimated economic life of 10 years, with no residual value. Pharoah depreciates similar buildings using the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Pharoah’s incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Pharoah, Inc.
(f) The yearly rental payment includes $14200 of executory costs related to taxes on the property.
Pharoah, Inc. would record amortization expense on this asset in 2021 of (Rounded to the nearest dollar.)
As conditions for the finance lease are fulfilled for lessee it is a Finance lease.
Under finance lease amortization expense is recorded to amortize right of use asset which is calculated by using SLM method.
If the ownership of an asset is going to transfer to lessee at the end of the lease should be amortized over useful life of an asset.
Hence Amortization expense = Right of use asset (Book value to holt)
Useful life of an asset
= $4,55,000 / 10 years
Hence Option A is correct.
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