 # Lease Liability

Qbank QID-23194. Kachelmeyer, Inc., signs an agreement on 1 January 2005, to lease equipment from Henderson Company. The term of the lease is five years, and the estimated economic life of the asset is also five years. The agreement requires equal annual payments of \$36,285.90, with the first payment on 1 January 2005. Kachelmeyer’s incremental borrowing rate is 12 percent. Henderson’s implicit rate is 10 percent and is known to Kachelmeyer. The prime rate is 8 percent The balance in the capital lease (liability) account that will appear on the balance sheet of Kachelmeyer on 1 January 2005, after making the first lease payment will be: A) \$115,021. B) \$137,552. C) \$151,307. D) \$36,286. The correct answer was A. As of 1 January 2005, after making the first lease payment, the balance in the liability account will be \$151, 307 – \$36,285 = \$115,021 (difference due to rounding). ======================= Isn’t Liability after first payment should be – 151,307 - (36,285 - 0.1*151,307) = 130,152.7 ?

PV(MLP) = 151307.3206 [Use BGN more here] 1st PMT = 36,285.90 therefore Balance Sheet Book Amount = 151307.3206 - 36,285.90 = 115021.4206 = A? - Dinesh S

there’s no interest in the first payment because it was made at the start of the lease, so the entire payment went into the principal

what rate did you guys use ?

It should be MIN[incremental borrowing rate, implicit rate] hence I used 10% as the discount factor. - Dinesh s

I have two thoughts: 1. The question asks what would be the amount after the first 'lease payment" rather than what would be the amount after the first payment(which might then include interest). So you just do PV minus “Lease PMT.” Following this thought, the answer is A. 2. Since first payment is made at the beginning, then you can simply use N=4 to get the PV, which will directly give you \$115,021. 3. I think I remember from my study that lease payment has two components: Depreciation + Interest. So the given lease payment shld already include interest. Following this thought, the answer is also A. Do you guy agree with me that lease payment already include interest expense? What bothers me is that for capital lease, you don’t make equal annual payments (the Q says 5 equal payments), the payment shld decrease each year. Hypothetically, if the questions asks for the balance after 2nd payment, then what would it be? Shld we do PV - Lease PMT*2 or we have to subtract interest?