Kauffman Tire Repair leased a machine that will enable it to repair tires found on monster vehicles. The annual payments are $9,000 and the life of the lease is 7 years. It is estimated that the useful life of the machine is 8 years. How would the company record the acquisition of the machine?

Question

Quizplus · Accepted Answer

If the lease is considered an operating lease, the company would not record the machine as an asset. Instead, it would record the lease payments as rent expense over the lease term. However, based on the information provided, it seems more likely that the lease could be classified as a finance lease because the lease term covers a significant portion of the useful life of the machine (7 out of 8 years).
Under a finance lease, the lessee (Kauffman Tire Repair) would record the machine as an asset and a corresponding lease liability at the inception of the lease. The amount recorded would be the present value of the lease payments, not the total of the payments ($9,000 for 7 years). The discount rate used to calculate the present value would typically be the interest rate implicit in the lease if it is readily determinable, or the lessee's incremental borrowing rate.
Therefore, the correct answer is:
c. The machine would be recorded as an asset, at the present value of the annual cash payments, $9,000 for 7 years.
The present value would be calculated using the appropriate discount rate, and the asset and liability would be amortized over the lease term. The $63,000 figure (which is simply $9,000 multiplied by 7 years) would not be used unless coincidentally it equals the present value calculation. The $6,000 figure mentioned in option d is not relevant to the scenario provided, as the annual payments are $9,000, not $6,000, and the lease term is 7 years, not 8 years.

Kauffman Tire Repair Leased a Machine That Will Enable It