On December 31, year 1, Roe Co. leased a machine from
Colt for a five-year period. Equal annual payments under the
lease are $105,000 (including $5,... Accounting MCQs | Accounting MCQs

On December 31, year 1, Roe Co. leased a machine from
Colt for a five-year period. Equal annual payments under the
lease are $105,000 (including $5,000 annual executory costs) and
are due on December 31 of each year. The first payment was
made on December 31, year 1, and the second payment was
made on December 31, year 2. The five lease payments are discounted
at 10% over the lease term. The present value of minimum
lease payments at the inception of the lease and before the
first annual payment was $417,000. The lease is appropriately
accounted for as a capital lease by Roe. In its December 31, year
2 balance sheet, Roe should report a lease liability of

$317,000
$315,000
$285,300
$248,700Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

(d) The initial lease liability at 12/31/Y1 is $417,000
(the PV of the minimum lease payments). The annual executory
costs ($5,000) are not an expense or liability until incurred;
therefore, they are excluded from the minimum lease payments
and are not reflected in the initial lease liability. The 12/31/Y1
payment of $105,000 includes $5,000 of executory costs; the
remainder ($100,000) is entirely principal since the payment was
made at the inception of the lease. Therefore, after the 12/31/Y1
payment, the lease liability is $317,000 ($417,000 – $100,000).
The 12/31/Y2 payment consists of executory costs ($5,000),
interest incurred during year 2 ($317,000 × 10% = $31,700), and
reduction of principal ($105,000 – $5,000 – $31,700 = $68,300).
Therefore, the 12/31/Y2 balance sheet should include a lease
liability of $248,700 ($317,000 – $68,300).