Question

Question: The following facts pertain to a noncancelable lease agreement between Faldo Leasing Company and Vance Company, a lessee.

Inception date	January 1, 2017
Annual lease payment due at the beginning of each year, beginning with January 1, 2017	\(124,798
Residual value of equipment at end of lease term, guaranteed by the lessee	\)50,000
Lease term	6 years
Economic life of leased equipment	6 years
Fair value of asset at January 1, 2017	\(600,000
Lessor’s implicit rate	12%
Lessee’s incremental borrowing rate	12%

The lessee assumes responsibility for all executory costs, which are expected to amount to \)5,000 per year. The asset will revert to the lessor at the end of the lease term. The lessee has guaranteed the lessor a residual value of $50,000. The lessee uses the straightline depreciation method for all equipment.

Instructions

(a) Prepare an amortization schedule that would be suitable for the lessee for the lease term.

Short answer

PV of minimum lease payments = $600,000.

Step-by-step solution

Meaning of lease asset amortization

The amortization of a leased asset is determined by the asset's historical cost, expected economic life, residual value, and the amortization method. Most finance leases are amortized with continuous payments over the term of the lease and are customized to meet the specific needs of the lessee.

Preparing an amortization schedule that would be suitable for the lessee for the lease term

VANCE COMPANY (Lessee) Lease Amortization Schedule
Date	Annual Lease Payment Plus GRV	Interest (12%) in Liability	Reduction of Lease Liability	Lease Liability
1/1/17				$600,000
1/1/17	$124,798	$ 0	$124,798	475,202
1/1/18	124,798	57,024	67,774	407,428
1/1/19	124,798	48,891	75,907	331,521
1/1/20	124,798	39,783	85,015	246,506
1/1/21	124,798	29,581	95,217	151,289
1/1/22	124,798	18,155	106,643	44,646
12/31/22	50,000	5,354	44,646	0

Working Notes:

Note:Since the lease period (six years) exceeds 75% of the asset's remaining economic life, it is a capital lease to the lessee (six years). Furthermore, the present value of the minimum lease payments surpasses 90% of the asset's fair value.

The rounding error is $1

The rounding error is $3

Annual rental payment	$ 124,798
PV of an annuity-due of 1 for n = 6,i= 12%	4.60478
PV of periodic rental payments	$ 574,668

Guaranteed residual value	$ 50,000
PV for 1 for n=6,i=12%	.50663
PV of guaranteed residual value	$25,322

PV of periodic rental payments	$ 574,668
PV of guaranteed residual value	+ 25,332
PV of minimum lease payments	$ 600,000