Johnson Ltd enters into a lease agreement with Peterson Ltd under the following conditions: The lease may be cancelled only with the permission of the lessor.If the rate of interest implicit in the lease is 10 per cent,what is the fair value of the asset at the inception of the lease,and is the lease a finance or operating lease?

Question

Johnson Ltd enters into a lease agreement with Peterson Ltd under the following conditions:  The lease may be cancelled only with the permission of the lessor.If the rate of interest implicit in the lease is 10 per cent,what is the fair value of the asset at the inception of the lease,and is the lease a finance or operating lease?

Quizplus · Accepted Answer

To determine the fair value of the asset at the inception of the lease, we need to calculate the present value of lease payments using the implicit interest rate of 10%. 
Using a present value table or calculator, we find the present value of lease payments to be $52,596. Therefore, this is the fair value of the asset at the inception of the lease. 
Since the fair value is lower than the expected market value of the asset, the lease is a finance lease. 
Option D is the correct answer.

Johnson Ltd Enters into a Lease Agreement with Peterson Ltd