On January1st,2014,ABC Inc.(the lessor)agrees to lease a piece of specialized piece of machinery to DEF Inc.(the lessee)for 5 years.ABC Inc.is a financial intermediary specializing in leasing arrangements such as the one described below.Details are as follows: Fair value of machinery at inception of the lease: $100,000. Lease term: 5 years (no bargain renewal terms). Executory costs of $10,000 are reimbursed by the lessee. 5 Annual lease payments of $23,000 each are made on January 1^st of each year starting on January 1^st,2014. Bargain purchase option at end of lease: $5,000.It is estimated that the equipment will have a fair value of $10,000 at the end of the lease. Economic life of the asset is 10 years,after which the equipment will be worthless.Straight-line depreciation applies. ABC's implicit interest rate with respect to this lease is 10%.This is rate is known by DEF Inc. DEF Inc's incremental borrowing rate is 9%. Assuming that this qualifies as a finance lease,at what amount would DEF Inc.capitalize the leased machinery at the inception of the lease as per ASPE (rounded)?

Question

Quizplus · Accepted Answer

Under ASPE, the lessee capitalizes the leased asset at the lower of its fair value and the present value of minimum lease payments at the inception of the lease.

First, we need to calculate the present value of minimum lease payments. Using the implicit interest rate of 10%, we can use either the annuity due or annuity formula to find the present value.

PV of annuity due = $23,000 x ((1 - 1/(1+10%)^5) / 10%) = $92,919.96

Next, we compare the fair value of the machinery ($100,000) to the present value of minimum lease payments ($92,919.96), and take the lower of the two. Therefore, the amount that DEF Inc. would capitalize the leased machinery at the inception of the lease is $100,764 (the lower of $100,000 and $92,919.96).

Therefore, the correct answer is B.