Question

(Lessee Computations and Entries, Capital Lease with Unguaranteed Residual Value) Assume the same data as in P21-10 with National Airlines having an incremental borrowing rate of 10%.

George Company manufactures a check-in kiosk with an estimated economic life of 12 years and leases it to National Airlines for a period of 10 years. The normal selling price of the equipment is $278,072,anditsunguaranteedresidualvalueattheendoftheleasetermisestimatedtobe$20,000. National will pay annual payments of $40,000atthebeginningofeachyearandallmaintenance,insurance,andtaxes.Georgeincurredcostsof$180,000 in manufacturing the equipment and $4,000 in negotiating and closing the lease. George has determined that the collectibility of the lease payments is reasonably predictable, that no additional costs will be incurred, and that the implicit interest rate is 10%.

Instructions

(a) Discuss the nature of this lease in relation to the lessee, and compute the amount of the initial lease liability.

Short answer

The lease is a capital lease

Initial lease liability is $270,361.

Step-by-step solution

Meaning of Lease liability

Lease liability means the amount of the lease liability in respect of any lease that would be required to be included in the statement of financial position prepared in accordance with the IFRS at the time of any determination and shall have a maturity period before the first date of such lease.

Explaining the nature of the lease in relation to the lessee

Since the lease term exceeds 75 percent of the asset's economic life (10/12 = 83 percent) and the present value of the minimum lease payments exceeds 90 percent of the leased asset's fair value, the lease is classified as a capital lease.

Computation of the amount of the initial lease liability

Initial Lease Liability:
Minimum lease payments ($40,000) X PV of an annuity due for 10 periods at 10% (6.75902	$270,361