Cpa Review

Q: On January 1, Year One, a company leases equipment for 8 years although the equipment has a life of 10 years. At the end of that time, title to this property will be conveyed to the lessee. Payments are $10,000 per year on January 1 with the first one made immediately. The present value of these payments at the lessee’s incremental borrowing rate of 10 percent per year is assumed to be $58,000. What amount of depreciation expense should the lessee recognize for Year One?

A: Because of the title transfer, this is viewed as a capital lease. The lessee records the asset at the present value of $58,000. Title is being transferred to the lessee. Hence, the lessee will use the asset for all ten years of its life rather than just the 8 years of the contract. Depreciation should be $5,800 per year ($58,000/10 years).

Q: Arton Company borrows $1 million from the Second National Bank on January 1, Year One with annual interest of 8 percent. The loan is to be repaid in five years. On January 1, Year Three, when Arton now owes a total of $1,120,000, the parties meet to restructure the agreement. On that date, the prime interest rate is 10 percent but the interest rate for questionable loans is 16 percent. Arton puts forth a restructuring plan which says that the principal will be reduced to $600,000 due in exactly five years and that annual interest of 10 percent will be paid every December 31 during that time. For this computation assume that the present value of $1 in five years at 8 percent annual interest is .66, at 10 percent is .60, and at 16 percent is .45. Assume that the present value of an ordinary annuity of $1 for five years at 8 percent annual interest is 3.93, at 10 percent is 3.72, and at 16 percent is 3.25. Assume that the present value of annuity due of $1 for five years at 8 percent annual interest is 4.27, at 10 percent is 4.10, and at 16 percent is 3.80. If the plan is accepted, what gain is recorded by Arton and what interest expense is recognized...