Detailed Answer
(b) This is a capital lease since the lease term (ten years)
is the same as the useful life of the leased asset. In a capital lease,
the lessee records an asset and a liability based on the PV of the
minimum lease payments. The minimum lease payments includes
rentals and a guaranteed residual value, if guaranteed by
the lessee. In this case the minimum lease payments include
only the rentals, since the residual value is guaranteed by a third
party. The minimum lease payments are discounted using the
lower of the lessee’s incremental borrowing rate or the implicit
rate used by the lessor, if known. In this case, the lessee knows
the implicit rate is 10%, which is lower than the incremental borrowing
rate of 12%. Thus, the present value or principal amount
of the lease obligation is $61,446 ($10,000 × 6.1446) through the
first year. Although accrued interest would be recognized at
10/31/Y1, the principal amount does not change until 1/1/Y2.