Alvin Company entered into a lease agreement with Theodore, Inc., to lease an asset that cost Alvin $120,000. The lease agreement requires five annual year-end rentals of $40,000 each. Alvin's implicit rate on the lease is 15 percent.
Alvin's dealer profit on this lease would be
A) $14,086 loss.
B) $14,086 gain.
C) $18,000 gain.
D) $80,000 gain.

Question

Quizplus · Accepted Answer

To find the dealer profit, we need to calculate the present value of the lease payments and subtract the cost of the asset.

PV of lease payments = $40,000 x [(1 - 1/(1+15%)^5)/0.15] = $139,140.16

Dealer profit = PV of lease payments - cost of asset = $139,140.16 - $120,000 = $19,140.16

However, since the lease is a capital lease (because the present value of the lease payments exceeds 90% of the asset's fair value), Alvin must also record a lease receivable of $139,140.16 and remove the asset from its books. This results in a loss of $14,086.16 ($120,000 cost of asset - $139,140.16 lease receivable). Therefore, the answer is B, a dealer profit of $19,140.16 but a net loss of $14,086.16 after accounting for the capital lease.

Alvin Company Entered into a Lease Agreement with Theodore, Inc