The Irish Inn is contemplating the purchase or lease of a new dryer. Tip 'Reilly, owner...

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The Irish Inn is contemplating the purchase or lease of a new dryer. Tip 'Reilly, owner of the Irish Inn, believes that the lease would not be capitalized and thus his financial ratios would not be adversely affected by the lease. He has asked you to examine the proposed arrangement, which is as follows: Term of lease: Estimated life of dryer: Average cost of debt: Incremental cost of debt: Lease payments due: -first payment due at signing (January 1, 20X1) -next five payments annually beginning January 1, 20X2 Annual lease payment: $1,000 First lease payment: $1,000 Fair market value: $4,500 There is also no option to buy at the end of lease; the dryer reverts to lessor at the end of the lease period. Required: 1. Is the owner correct in his belief that the lease would not be capitalized? Show all your work in arriving at your decision. 2. What is the present value of the lease payment stream? 3. Prepare the journal entry to record the lease assuming it will be capitalized. 4. What is the amount of interest for 20X1? 5. What is the amount of interest over the life of the lease (20X1-20X5)? The Irish Inn is contemplating the purchase or lease of a new dryer. Tip 'Reilly, owner of the Irish Inn, believes that the lease would not be capitalized and thus his financial ratios would not be adversely affected by the lease. He has asked you to examine the proposed arrangement, which is as follows: Term of lease: Estimated life of dryer: Average cost of debt: Incremental cost of debt: Lease payments due: -first payment due at signing (January 1, 20X1) -next five payments annually beginning January 1, 20X2 Annual lease payment: $1,000 First lease payment: $1,000 Fair market value: $4,500 There is also no option to buy at the end of lease; the dryer reverts to lessor at the end of the lease period. Required: 1. Is the owner correct in his belief that the lease would not be capitalized? Show all your work in arriving at your decision. 2. What is the present value of the lease payment stream? 3. Prepare the journal entry to record the lease assuming it will be capitalized. 4. What is the amount of interest for 20X1? 5. What is the amount of interest over the life of the lease (20X1-20X5)?

Answer rating: 100% (QA)

To determine whether the lease should be capitalized we need to consider the criteria set forth in the accounting standard for leases which is usually based on the guidance from the Financial Accounti... View the full answer