On January 1st, 2014, ABC Inc.(the lessor)agrees to lease a piece of specialized piece of machinery to DEF Inc.(the lessee)for 5 years.ABC Inc.is a financial intermediary specializing in leasing arrangements such as the one described below.Details are as follows: Fair value of machinery at inception of the lease: $100,000.Lease term: 5 years (no bargain renewal terms).
Executory costs of $10,000 are reimbursed by the lessee.
5 Annual lease payments of $23,000 each are made on January 1st of each year starting on January 1st, 2014.
Bargain purchase option at end of lease: $5,000.It is estimated that the equipment will have a fair value of $10,000 at the end of the lease.
Economic life of the asset is 10 years, after which the equipment will be worthless.Straight-line depreciation applies.
ABC's implicit interest rate with respect to this lease is 10%.This is rate is known by DE Inc.
DEF Inc's incremental borrowing rate is 9%.
Assuming that this qualifies as a finance lease, at what amount would DEF Inc.capitalize the leased machinery at the inception of the lease as per ASPE (rounded)?
A)$100,764
B)$95,907
C)$99,011
D)$100,000

Question

Quizplus · Accepted Answer

The correct answer is A because the capitalized amount of the leased machinery at the inception of the lease is $100,764. This is calculated as follows:Present value of lease payments = $23,000 x (PVAF5%,5) = $95,907Present value of bargain purchase option = $5,000 x (PVF10%,5) = $3,357Capitalized amount of leased machinery = $95,907 + $3,357 + $10,000 (executory costs) = $100,764