Oak Co. leased equipment for its entire nine-year useful life,
agreeing to pay $50,000 at the start of the lease term on December
31, year 1, and $5... Accounting MCQs | Accounting MCQs

Oak Co. leased equipment for its entire nine-year useful life,
agreeing to pay $50,000 at the start of the lease term on December
31, year 1, and $50,000 annually on each December 31 for
the next eight years. The present value on December 31, year 1,
of the nine lease payments over the lease term, using the rate
implicit in the lease which Oak knows to be 10%, was $316,500.
The December 31, year 1 present value of the lease payments
using Oak’s incremental borrowing rate of 12% was $298,500.
Oak made a timely second lease payment. What amount should
Oak report as capital lease liability in its December 31, year 2
balance sheet?

$350,000
$243,150
$228,320
$0Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

(b) This is a capital lease for the lessee because the lease
term (nine years) exceeds 75% of the useful life of the machine
(also nine years). For a capital lease, the lessee records as a
leased asset and a lease obligation at the lower of the PV of the
minimum lease payments or the FV of the leased asset (not given
in this problem). The PV of the minimum lease payments is
computed using the lower of the lessee’s incremental borrowing
rate (12%) or the implicit rate used by the lessor if known by the
lessee (10%). Since the implicit rate is lower, and known by the
lessee, it is used to compute the PV ($316,500). The initial lease
payment ($50,000) is entirely principal because it was made at
the inception of the lease. Therefore, after the 12/31/Y1 payment,
the lease liability is $266,500 ($316,500 – $50,000). The
12/31/Y2 payment consists of interest incurred during year 2
($266,500 × 10% = $26,650) and principal reduction ($50,000 –
$26,650 = $23,350). Therefore, the 12/31/Y2 capital lease liability
is $243,150 ($266,500 – $23,350).