[ab29]

I’m confused on capital leases.I am having trouble distinguishing when to subtract out the payment on the lease. I provided two examples below. For the question pertaining to Babson, the $13,000 payment is subtracted but for the example pertaining to Blaugh the $9,000 payment isn’t subtracted. I was wondering if someone can help me differentiate between the two.

On January 1, 1990, Babson, Inc. leased two automobiles for executive use. The lease requires Babson
to make five annual payments of $13,000 beginning January 1, 1990. At the end of the lease term,
December 31, 1994, Babson guarantees the residual value of the automobiles will total $10,000. The
lease qualifies as a capital lease. The interest rate implicit in the lease is 9%. Present value factors for
the 9% rate implicit in the lease are as follows:
For an annuity due with 5 payments 4.240
For an ordinary annuity with 5 payments 3.890
Present value of $1 for 5 periods 0.650
Babson’s recorded capital lease liability immediately after the first required payment should be:
a. $48,620
b. $44,070
c. $35,620
d. $31,070
CPA-00574 Explanation
Choice “a” is correct. $48,620 capital lease liability after first required payment.
Annual payments $ 13,000
PV of annuity due (at beginning of year) ×4.240
PV of annual payments before first required payment 55,120
Less first payment (Jan. 1, 1990) (13,000)
PV of annual payments after first required payment 42,120
Add PV of guaranteed residual value (PV of $ for 5 periods 0.650 x $10,000) 6,500
Capital lease liability after first required payment $48,620

On January 1, Blaugh Co. signed a long-term lease for an office building. The terms of the lease required Blaugh to pay $10,000 annually, beginning December 30, and continuing each year for 30 years. The lease qualifies as a capital lease. On January 1, the present value of the lease payments is $112,500 at the 8% interest rate implicit in the lease. In Blaugh’s December 31 balance sheet, the capital lease liability should be
A. $102,500
B. $111,500
Answer (B) is correct.
A lease payment has two components: interest expense and the portion applied to the reduction of the lease obligation. The effective-interest method requires that the carrying amount of the obligation at the beginning of each interest period be multiplied by the appropriate interest rate to determine the interest expense. The difference between the minimum lease payment and the interest expense is the amount of reduction in the carrying amount of the lease obligation. Consequently, interest expense is $9,000 ($112,500 BOY liability balance × 8% implicit rate), and the reduction in the lease obligation is $1,000 ($10,000 cash – $9,000 interest expense). The new balance of the lease obligation is thus $111,500 ($112,500 – $1,000).
C. $112,500
D. $290,000

[Anonymous]

@ab29 it's all based on the date which you pay. In the first example, you pay on day 1 (an annuity due) which means there hasn't been any interest incurred yet. In the second example, you pay on 12.31 meaning you need to cal the interest (112,500 * 8% = 9000) and subtract that amount from the amount paid (10,000 payment – 9000 Interest = $1,000 against principle).

Hope that helps

[Thao]

Look at the date.
If payment is due on the first day of entering into the lease, the whole payment will be subtracted from the Present Value of the Lease Liability because there is no interest accrued on the first day. Debit Lease Liability and Credit Cash for the annual payment amount. If the payment is due like at the end of the year, there’s interest accrued. Debit Interest Expense and Lease Liability. Credit cash for the whole payment amount.

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[Lidis]

13,000×4.240= 55,120
10,000×0.650=.6,500
61,500 -13,000= 48,620

[Author]

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