[Anonymous]

On January 1, 1990, Babson, Inc. leased two automobiles for executive use. The lease requires Babson

to make five annual payments of $13,000 beginning January 1, 1990. At the end of the lease term,

December 31, 1994, Babson guarantees the residual value of the automobiles will total $10,000. The

lease qualifies as a capital lease. The interest rate implicit in the lease is 9%. Present value factors for

the 9% rate implicit in the lease are as follows:

For an annuity due with 5 payments 4.240

For an ordinary annuity with 5 payments 3.890

Present value of $1 for 5 periods 0.650

Babson’s recorded capital lease liability immediately after the first required payment should be:

a. $48,620

b. $44,070

c. $35,620

d. $31,070

CPA-00574 Explanation

Choice “a” is correct. $48,620 capital lease liability after first required payment.

Annual payments $ 13,000

PV of annuity due (at beginning of year) ×4.240

PV of annual payments before first required payment 55,120

Less first payment (Jan. 1, 1990) (13,000)

PV of annual payments after first required payment 42,120

Add PV of guaranteed residual value (PV of $ for 5 periods 0.650 x $10,000) 6,500

Capital lease liability after first required payment $48,620

============================================================================================

My Question, I don’t really get the logic of this question. Babson leases the automobiles for its own executive use. Why Babson still needs to guarantee the residual value of the automobiles? Since this is a capital lease, the automobiles will transfer to Babson at the end of the lease anyway. In fact, I thought the PV of the residual value of the automobiles will reduce the liability of the lease. Am I misread the question here???? Can someone please explain the logic of the residual value?

[NYCaccountant]

The questions does not say that the cars will transfer to Babson at the end of the lease. Remember, a lease is defined as a capital lease when A.) There is a transfer of ownership at lease end or B.) The lease contains a bargain purchase or C.) The lease term is for 75% of the useful life of the asset or D.) the present value of the minimum lease payments is at least 90% of the fair value of the asset. You just need one of these present within the lease for it to qualify as a capital lease.

FAR - 93
REG - 87
BEC - 84!!!!
AUD - 99!!!!!! CPA exam complete.

[Anonymous]

thank you for replying

Isn't only Direct-Financing Lease & Sales-Type Lease will transfer the assets to the lessee at the end of the lease?

However, in sales-leaseback, lessee, the seller will retain the asset?

[Anonymous]

thank you for replying

Isn't only Direct-Financing Lease & Sales-Type Lease will transfer the assets to the lessee at the end of the lease?

However, in sales-leaseback, lessee, the seller will retain the asset?

[Author]

Replies