Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 100

Present value calculation — capital lease Renter Co. acquired the use of a machine by agreeing to pay the manufacturer of the machine $900 per year for 10 years. At the time the lease was signed, the interest rate for a 10-year loan was 12%.

Required:

a. Use the appropriate factor from Table 6-5 to calculate the amount that Renter Co. could have paid at the beginning of the lease to buy the machine outright.

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b. What causes the difference between the amount you calculated in part a and the total of $9,000 ($900 per year for 10 years) that Renter Co. will pay under the terms of the lease?

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c. What is the appropriate amount of cost to be reported in Renter Co.’s balance sheet (at the time the lease was signed) with respect to this asset?

Step 1 of 3

a. The cost of the machine at the beginning of the lease is the present value of the lease payments discounted at the interest rate the lessor would charge.  The $900 annual lease payment is an annuity.  The present value factor for an annuity of 10 periods at a discount rate of 12% in Table 6-5 is 5.6502.  Thus, the present value of the lease payments is:

$900 * 5.6502 = $5,085