leasing question help!

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sisi
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At the beginning of year 2, Kennedy enters into a four-year operating lease with payment due at the end of the year beginning on December 31.year2.
the rate implicit in the lease is 4.50 percent and Kennedy will owe annual payments of \$5,200. the present value factor of an ordinary annuity for four years at 4.50 percent is equal to 3.5875.
the carrying value of the ROU asset at the end of year 2 will be closest to:
A.\$ 9740
B.\$14,295
c.\$18,655
D,\$13,455

the correct answer is B:\$14,295, and why? i'm confused that why operating lease involved with the interest rate? i thought it only has to do with capital lease.

DocJ
Participant

First step of any lease problem like this: Find out the present value of the lease payments. In this case, you're paying a \$5,200 annuity, times the 3.5875 present value factor = \$18,655 present value at the start of Year 2. That's your beginning Carry Value, AKA “Lease Liability” (remember that term).

Then December rolls around and you gotta make your first \$5,200 payment. Thing is, this payment is a combination of principle and interest. Your job is basically to break it out between the two.

To do that, multiply the implicit rate (or incremental borrowing rate if it's lower) by your Lease Liability, that \$18,655. So 4.5% times \$18,655 = \$840 interest. This is just me, but it really helps to remember Interest = Principle * Rate * Time.

Next, figure out the different between your payment (the \$5,200) and the interest portion of that payment (\$840). So \$5200 – \$840 = \$4,360. Now this number is important cuz that's your Lease Liability payment. You got \$840 interest, and the other \$4360 pays off your Lease Liability.

\$18,655 – \$4,360 = \$14,295. Ta-da :p

Yeah, it's convuluted, and I know the question asked for Carrying Value, but TBH that's kinda interchangeable in this case with Lease Liability, which is the more frequently-used term on the exam (at least in my experience). And yes, this qualifies to Operating Leases as well as Capital Leases, you're still making the payments and interest and stuff regardless of what type of lease it is.

sisi
Participant

First step of any lease problem like this: Find out the present value of the lease payments. In this case, you're paying a \$5,200 annuity, times the 3.5875 present value factor = \$18,655 present value at the start of Year 2. That's your beginning Carry Value, AKA “Lease Liability” (remember that term).

Then December rolls around and you gotta make your first \$5,200 payment. Thing is, this payment is a combination of principle and interest. Your job is basically to break it out between the two.

To do that, multiply the implicit rate (or incremental borrowing rate if it's lower) by your Lease Liability, that \$18,655. So 4.5% times \$18,655 = \$840 interest. This is just me, but it really helps to remember Interest = Principle * Rate * Time.

Next, figure out the different between your payment (the \$5,200) and the interest portion of that payment (\$840). So \$5200 – \$840 = \$4,360. Now this number is important cuz that's your Lease Liability payment. You got \$840 interest, and the other \$4360 pays off your Lease Liability.

\$18,655 – \$4,360 = \$14,295. Ta-da :p

Yeah, it's convuluted, and I know the question asked for Carrying Value, but TBH that's kinda interchangeable in this case with Lease Liability, which is the more frequently-used term on the exam (at least in my experience). And yes, this qualifies to Operating Leases as well as Capital Leases, you're still making the payments and interest and stuff regardless of what type of lease it is.

thank you so much! i'm cleared

sisi
Participant

thank you so much!!!!!!

Viewing 4 posts - 1 through 4 (of 4 total)