Question

At January 1, 2021, Café Med leased restaurant equipment from Crescent Corporation under a nine-year lease agreement. The lease agreement specifies annual payments of $25,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 thereafter through 2028. The equipment was acquired recently by Crescent at a cost of $180,000 (its fair value) and was expected to have a useful life of 12 years with no salvage value at the end of its life. (Because the lease term is only 9 years, the asset does have an expected residual value at the end of the lease term of $50,995.) Crescent seeks a 10% return on its lease investments. By this arrangement, the lease is deemed to be a finance lease. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. What will be the effect of the lease on Café Med’s earnings for the first year? (ignore taxes) (Enter decreases with negative sign.) 2. What will be the balances in the balance sheet accounts related to the lease at the end of the first year for Café Med? (ignore taxes)

Answer 1

1. Right to use assets $158,373

Effect on earnings for first year $30,937

2. Ending lease payable balance $121,710

Right of use asset balance (end of year) $140,776

1. Calculation to determine  what will be the effect of the lease on Café Med’s earnings for the first year

First step is to determine the cumulative PV factor for annuity due at 10% for 9 periods

Cumulative PV factor for annuity due at 10% for 9 periods=6.334926

Second step is to calculate the Right to use assets

Right to use assets=Annual lease payment×Cumulative PV factor for annuity due at 10% for 9 periods  

Right to use assets=25000×6.334926

Right to use assets=158373

Third step is to calculate the interest expenses

Interest expense= [(158373-25000)*10%]

Interest expense=-13337

Fourth step is to calculate the amortization for the year

Amortization for the year=158373/9 years

Amortization for the year=17597

Now let determine the Effect on earnings for first year

Effect on earnings for first year=-13337-17597

Effect on earnings for first year=$30,937

2. Calculation to determine what will be the balances in the balance sheet accounts related to the lease at the end of the first year

Ending lease payable balance=$158,373+$13,337-$25,000-$25,000

Ending lease payable balance=$121,710

Right of use asset balance (end of year)=Begining balance-Amortization-

Right of use asset balance (end of year)=$158373-17597

Right of use asset balance (end of year)=$140,776

Inconclusion:

1. Right to use assets $158,373

Effect on earnings for first year $30,937

2. Ending lease payable balance $121,710

Right of use asset balance (end of year) $140,776

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