The fair value of leased equipment equals the present value of rentals. (Assume the lease is capitalized.)
On January 1, Year 1, Burton Company leases equipment from Nelson Company for an annual lease rental of $10,000. The lease term is five years, and the lessor”s interest rate implicit in the lease is 8%. The lessee”s incremental borrowing rate is 8.25%. The useful life of the equipment is five years, and its estimated residual value equals its removal cost. Annuity tables indicate that the present value of an annual lease rental of $1 (at 8% rate) is $3.993. The fair value of leased equipment equals the present value of rentals. (Assume the lease is capitalized.)
a. Prepare accounting entries required by Burton Company for Year 1.
b. Compute and illustrate the effect on the income statement for the year ended December 31, Year 1, and for the balance sheet as of December 31, Year 1.
c. Construct a table showing payments of interest and principal made every year for the five-year lease term.
d. Construct a table showing expenses charged to the income statement for the five-year lease term if the equipment is purchased. Show a column for (1) amortization, (2) interest, and (3) total expenses.
e. Discuss the income and cash flow implications from this capital lease.