[TheGoodCPA]

In the long-term liabilities section of its balance sheet at December 31, Year 1, Mene Co. reported a capital lease obligation of $75,000, net of current portion of $1,364. Payments of $9,000 were made on both January 2, Year 2, and January 2, Year 3. Mene’s incremental borrowing rate on the date of the lease was 11% and the lessor’s implicit rate, which was known to Mene, was 10%. In its December 31, Year 2, balance sheet, what amount should Mene report as capital lease obligation, net of current portion?

a. $73,500

b. $74,250

c. $66,000

d. $73,636

Explanation

Choice “a” is correct. The lesser of the lessee’s incremental borrowing rate or the lessor’s implicit rate (if known) should be used.

Question: so I understand how to calculate this problem, however the dating of the interest confuses me. Since the liability is recorded 12/31/year 1, and the first interest payment is 1/2/year 2, doesn’t that mean it’s an annuity due (payment is due first day of year)?

If it’s annuity due, why do you subtract interest ($7636) from $9000 during the first year (year 2)? In the text it says if it’s annuity due you would just subtract ($9000) principal only without the interest from the PV of $76364 during the first year.

AUD - 83 (5/13/16)
FAR - 77 (7/20/16)
BEC - (8/12/16)
REG - (10/15/16)

[rybread7293]

Jeff posted this a while back for someone else also stumped on the same question. I would've tried to explain it myself since I know how to do it, but this is much simpler and a great explanation:

At December 31, 20X1, the total lease liability was $76,364 (the sum of the current portion of $1,364 and the long-term portion of $75,000).

The $9,000 payment made on January 2, 20X2, was for the $1,364 current portion and the interest of $7,636 ($9,000 – $1,364). After the January 2, 20X2, payment, the total lease liability is $75,000.

Interest for 20X2 is $7,500 ($75,000 × 10% implicit rate). Therefore, the reduction in principal that will be included in the January 2, 20X3, payment will be $1,500, which is the $9,000 payment minus $7,500 interest for 20X2.

This $1,500 represents the current portion of the lease liability. Therefore, the long-term portion of the liability at December 31, 20X2, is the $75,000 total lease liability less the $1,500 current portion, or $73,500.

Keep on keepin' on.

FAR (4/21/16) - 91
AUD (5/23/16) - 97
REG - 7/26/16
BEC - 8/24/16

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