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(Lessee-Lessor Accounting for Residual Values) Goring Dairy leases its milking equipment from King Finance Company under the following lease terms.

1. The lease term is 10 years, noncancelable, and requires equal rental payments of \(30,300 due at the beginning of each year starting January 1, 2017.
2. The equipment has a fair value and cost at the inception of the lease (January 1, 2017) of \)220,404, an estimated economic life of 10 years, and a residual value (which is guaranteed by Goring Dairy) of \(20,000.
3. The lease contains no renewable options, and the equipment reverts to King Finance Company upon termination of the lease.
4. Goring Dairy鈥檚 incremental borrowing rate is 9% per year. The implicit rate is also 9%.
5. Goring Dairy depreciates similar equipment that it owns on a straight-line basis.
6. Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor.

Instructions

(c) What would have been the amount capitalized by the lessee upon the inception of the lease if:

1. The residual value of \)20,000 had been guaranteed by a third party, not the lessee?
2. The residual value of $20,000 had not been guaranteed at all?

Step by step solution

01

Meaning of Residual Value

The residual value of an asset is an estimate of how much money it will be worth once its useful life is through. To put it another way, it's the value of an asset once it's been fully utilized.

02

Explaining the amount that should be capitalized by the lessee upon the inception of the lease

In both, the situation when the residual value of $20,000 had been guaranteed by a third party, not the lessee, and the residual value of $20,000 had not been guaranteed at all results in the same lease liability of annuity of $ $211,956, since the lessee has no obligation to pay the residual value.

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