has a 12% incremental borrowing rate.

The equipment is expected to have an estimated

useful life of ten years. In addition, a third party has guaranteed to pay Ward a residual
value of $5,000 at the end of the lease.

Present Value of an ordinary annuity of $1 for ten years at:

12%: 5.6502
10%: 6.1446

Present Value of $1 for ten years at:

12%: 0.3220
10%: 0.3855

In Day's October 31, year 1 balance sheet, the principal amount of the lease obligation
was

a. $63,374
b. $61,446
c. $58,112
d. $56,502
Correct Answer: B) $61,446

Notes

(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.
28. Robbins, Inc. leased a machine from Ready Leasing Co. The lease qualifies as a
capital lease and requires ten annual payments of $10,000 beginning immediately. The
lease specifies an interest rate of 12% and a purchase option of $10,000 at the end of
the tenth year, even though the machine's estimated value on that date is $20,000.
Robbins' incremental borrowing rate is 14%.

Present value of an annuity due of one for 10 years at:

12%: 6.328
14%: 5,946

Present value of one for 10 years at:

12%: 0.322
14%: 0.270

What amount should Robbins record as lease liability at the beginning of the lease
term?

a. $62,160
b. $64,860
c. $66,500
d. $69,720
Correct Answer: C) $66,500

29. Neal Corp. entered into a nine-year capital lease on a warehouse on December 31,
year 1. Lease payments of $52,000, which includes real estate taxes of $2,000, are due
annually, beginning on December 31, year 2, and every December 31 thereafter. Neal
does not know the interest rate implicit in the lease; Neal's incremental borrowing rate is
9%. The rounded present value of an ordinary annuity for nine years at 9% is 5.6. What
amount should Neal report as capitalized lease liability at December 31, year 1?

a. $280,000
b. $291,200
c. $450,000
d. $468,000
Correct Answer: A) $280,000

Notes

(a) The annua l executory costs (real estate taxes of $2,000) 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 capital lease liability is
recorded at the PV of the minimum lease payments [5.6 × ($52,000 - $2,000) =
$280,000].
30. East Company leased a new machine from North Company on May 1, year 1, under
a lease with the following information:

Lease term: 10 years

Annual rental payable at beginning of each lease year: $40,000
Useful life of machine: 12 years
Implicit interest rate: 14%
Present value of an annuity of one in advance for 10 periods at 14%: 5.95
Present value of one for 10 periods at 14%: 0.27
East has the option to purchase the machine on May 1, year 11 by paying $50,000,