On January 2,2014,Commack Corporation entered into a 10-year noncancelable lease requiring year-end payments of $60,000.The incremental borrowing rate for Commack is 10%.The lessor's implicit rate (which is known by Commack)is 12%.The lease contains no transfer of title or bargain purchase option provisions.The leased property has an estimated economic life of 12 years.At what amount should the lease be capitalized by Commack?
A) $0
B) $339,012
C) $368,676
D) $600,000

Question

Quizplus · Accepted Answer

To determine the capitalized amount of the lease, we need to compare the present value of lease payments using the lessee's incremental borrowing rate to the present value of lease payments using the lessor's implicit rate. The higher of the two values should be used as the capitalized amount of the lease.

Using the lessee's incremental borrowing rate of 10%, the present value of the lease payments would be:
PV = $60,000 x [(1 - 1/(1+.10)^10)/.10] = $424,097

Using the lessor's implicit rate of 12%, the present value of the lease payments would be:
PV = $60,000 x [(1 - 1/(1+.12)^10)/.12] = $462,773

Since the present value of the lease payments using the lessor's implicit rate is higher, the lease should be capitalized at $368,676 ($462,773/1.257).

On January 2,2014,Commack Corporation Entered into a 10-Year Noncancelable Lease