Question

# Pharoah Company leases a building to Shamrock, Inc. on January 1, 2020. The following facts pertain...

Pharoah Company leases a building to Shamrock, Inc. on January 1, 2020. The following facts pertain to the lease agreement.

 1 The lease term is 5 years, with equal annual rental payments of \$4,910 at the beginning of each year. 2 Ownership does not transfer at the end of the lease term, there is no bargain purchase option, and the asset is not of a specialized nature. 3 The building has a fair value of \$23,500, a book value to Pharoah of \$16,500, and a useful life of 6 years. 4 At the end of the lease term, Pharoah and Shamrock expect there to be an unguaranteed residual value of \$4,125. 5 Pharoah wants to earn a return of 9% on the lease, and collectibility of the payments is probable. Shamrock was unaware of the implicit rate used in the lease by Pharoah and has an incremental borrowing rate of 10%.

How would Pharoah (lessor) and Shamrock (lessee) classify this lease?

 Pharoah would classify the lease as a                                                           finance or sales-type or operating lease. Shamrock would classify the lease as a                                                           operating or finance or sales-type lease.

How would Pharoah initially measure the lease receivable, and how would Shamrock initially measure the lease liability and right-of-use asset?

 Pharoah Lease receivable \$ Present value of lease pay \$
 Shamrock Lease Liability/Right-of-Use Asset \$

Pharoah would classify the lease as a Sales - type lease.

Shamrock would classify the lease as a  Finance lease.

Calculating Lease receivable for Pharoah

 Particulars Amount Annual Rent Payments 4,910 PVAD (5 years, 9%) 4.2397 Present value of Rental Payment (4,910 * 4.2397) (A) 20,817 Expected Residual value (Unguarantee) 4,125 PVF (5 years, 9%) 0.6499 Present Value of Residual Value (4,125 * 0.6499) (B) 2,680 Lease Receivable (A + B) 23,497

Calculating Present Value of lease pay for Pharoah

 Particulars Amount Annual Rent Payments 4,910 PVAD (5 years, 9%) 4.2397 Present value of Rental Payment (4,910 * 4.2397) 20,817

Lease Liability/Right - of - Use Asset = \$20,817

The initial lease liability for Pharoah is \$20,817

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