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 amount at which Kachelmeyer should capitalize the lease on 1 January 2005, is closest to: A) $146,499. B) $151,307. C) $137,552. D) $130,803. 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) $137,552. B) $151,307. C) $115,021. D) $36,286.

B and C

yup b and C

Wake: Can you walk me through this? I hate leases.

Set calculator to BGN

im good at solving, terrible at explaining these type problems, but make sure your calculator is in begin mode and that your FV is set to zero. when amortizing the lease amount that you computed in step 1, which should be $157K, make sure to take the difference between the annual lease payment and the interest expense payment which is the product of the capital lease obligation ($157K) and the implicit rate, and that difference should be subtracted from the capital lease obligation amount to get your answer for step 2.

wake can you walk us through the first year payment calculation? I cant believe I forgot this

Begin mode; N=5 PYMT=36,285.90 Use the lessor of incremental borrowing rate or implicit rate, which is I/Y=10 FV=0 CPT PV

i get that part… how about the interest expense vs payment calculation I get 151,307.32 * .10 = 15,130 So add 151,307.32 and 15,130 = 166,438.05 Subtract Payment - 36,285.90 I get 130,152.15 That is wrong clearly

The correct ans is B & C. Is my calucaltor is going crazy or m i making some silly mistake … i dont know why but its giving my PV as 137,552. Didnt quite get as why the second ans is C. while calculating the liability, interest has to be deducted from lease paymetn and then the remainig amt has to be deducted from capital lease. But here the entire lease payment is deducted from liability. can anyone explain?

yes you deduct the entire lease payment from the liability amount. interest expense and liability amortization which the diffrence between the interest expense and payment. the big difference is in the cash flow. in the cash flow you have to separate the payment into 2 components: interst expense that goes against CFO and you reduce the outflow in the financing section by the diffrence.

Maybe if someone can just walk through the actual numbers, beginning with year 1 liability, and interest expense, and lease payment, and end of year liability.

Liability Interest expense Amortization Ending balance 151307 15130.7 = 36285.9-15130.7= 211552 151307-15130.7- 21155 = 115021

sorry i think i explained this wrong because i thought the question asked for the ending balance at year 2, but it only asked for the balance after the lease payment, but the answer remains the same. there is no passage of time, so there should only be a reduction of the principal by the amount of the annual lease payment. sorry for the confusion. the answer will simply be 151,307 less the annual lease payment.

PV of lease payments 151,307 x .10 = 15,130.70 15,130.70 is your interest expense therefore does not show up on your liabilitieies account. It is part of your CFO. However what does show up is your liabilities account is your first PMT less your PV which would be 151,307 - 36,285.90 = 115,021 --> CFF Hope that clears some stuff for you