On December 30 of the current year, Haber Co. leased a new machine from Gregg Corp.

The following data relate to the lease transaction at the inception

of the lease:

Lease term 10 years

Annual rental payable at the end of each lease year $100,000

Estimated life of machine 12 years

Implicit interest rate 10%

Present value of an annuity of $1 in advance for

10 periods at 10% 6.76

Present value of an annuity of $1 in arrears for

10 periods at 10% 6.15

Fair value of the machine $700,000

The lease has no renewal option, and the possession of the machine reverts to Gregg when the lease terminates. At the inception of the lease, Haber

should record a lease liability of:

A.

$0

B.

$615,000

C.

$630,000

Incorrect D.

$676,000

You answered D. The correct answer is B.

This lease qualifies as a capital lease because the lease term of 10 years exceeds 75% of the asset’s useful life of 12 years (10 > 0.75 × 12 = 9). When a

lease is considered a capital lease, then the lessee capitalizes the lease property and recognizes a lease obligation for the present value of the minimum

lease payments.

The minimum lease payments here are the $100,000 a year at the end of each year, and their present value is 100,000 × 6.15 (present value of an annuity

in arrears or ordinary annuity, for 10 periods at 10%). Thus, the answer is $615,000:

100,000 × 6.15 = $615,000