On December 31, year 1, Day Co. leased a new machine
from Parr with the following pertinent information:
Lease term 6 years
Annual rental payable a... Accounting MCQs | Accounting MCQs

On December 31, year 1, Day Co. leased a new machine
from Parr with the following pertinent information:
Lease term 6 years
Annual rental payable at beginning of each year $50,000
Useful life of machine 8 years
Day’s incremental borrowing rate 15%
Implicit interest rate in lease (known by Day) 12%
Present value of annuity of 1 in advance for 6 periods at
12% 4.61
15% 4.35
The lease is not renewable, and the machine reverts to Parr at the
termination of the lease. The cost of the machine on Parr’s accounting
records is $375,500. At the beginning of the lease term,
Day should record a lease liability of

$375,500
$230,500
$217,500
$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 is 75% of the useful life of the machine [6 years = (75% × 8
years)]. For a capital lease, the lessee records as a leased asset
and a lease obligation 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 (15%) or the
implicit rate used by the lessor if known by the lessee (12%).
Since the implicit rate is lower, and known by the lessee, it is used
to compute the PV ($50,000 × 4.61 = $230,500). The cost of the
asset on the lessor’s books ($375,500) is irrelevant.