Each of the three independent situations below describes a finance lease in which annual lease payments are payable at the beginning of each year. The lessee is aware of the lessor's implicit rate of return. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Situation
1 2 3
Lease term (years) 12 20 4
Lessor’s rate of return (known by lessee) 11% 9% 12%
Lessee’s incremental borrowing rate 12% 10% 11%
Fair value of leased asset $620,000 $1,000,000 $205,000
Required:
a. Determine the amount of the annual lease payments as calculated by the lessor and above situations.
b. Determine the amount lessee would record as a leased asset and a lease liability for above situations.

Answer is explained in the explanation section below.

Explanation:

Data Given:

Situations:

Lease Term years:

1. 12

2. 20

3. 4

Lessor’s rate of return (known by lessee):

1. 11%

2. 9%

3. 12%

Fair value of leased asset:

1. $620,000

2. $1,000,000

3. $205,000

a)  For Situation 1:

Here, lease is a financial agreement between two parties Lesse and Lessor.

So,

Formula for annual lease payments is:

Annual lease payments = Fair value of assets divided by Present value for annuity due.

Here,

we use the following data to calculate the annual payments.

Fair Value of Assets of the leased asset = $620,000

Lease term = 12 years

Lessor's rate of return = 11%

So, the present value of annuity due 12 years at the rate of 11% is 7.2065

Plugging in the values in the formula we get:

Annual lease payments =

Annual lease payments = $86,033.44

b)

Formula for the lease ability = Annual rent payment multiply by present value of annuity due.

So,

The annual rent payment is the same that we calculated above.

So,

the lease ability = $86,033.44 x 7.2065

the lease ability = $620,000

For Situation 2:

a)

Annual lease payments = Fair value of assets divided by Present value for annuity due.

we use the following data to calculate the annual payments.

Fair Value of Assets of the leased asset = $1,000,000

Lease term = 20 years

Lessor's rate of return = 10%

So, the present value of annuity due 20 years at the rate of 9% is 9.9501

Annual lease payments =

Annual lease payments = $100,501.35

b)

Formula for the lease ability = Annual rent payment multiply by present value of annuity due.

the lease ability = $100,501.35 x 9.9501

the lease ability = $1,000,000

For Situation 3:

a)

Annual lease payments = Fair value of assets divided by Present value for annuity due.

we use the following data to calculate the annual payments.

Fair Value of Assets of the leased asset = $205,000

Lease term = 4 years

Lessor's rate of return = 12%

So, the present value of annuity due 4 years at the rate of 12% is 3.4081

Annual lease payments =

Annual lease payments = $60,261.66

b)

Formula for the lease ability = Annual rent payment multiply by present value of annuity due.

the lease ability = $60,261.66 x 3.4801

the lease ability = $205,000

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