Pat Delaney Company leases an automobile with a fair value of $8,725 from John Simon Motors, Inc., on the following terms:
1. Noncancelable term of 50 months.
2. Rental of $200 per month (at end of each month). (The present value at 1% per month is $7,840.)
3. Estimated residual value after 50 months is $1,180. (The present value at 1% per month is $715.) Delaney Company guarantees the residual value of $1,180.
4. Estimated economic life of the automobile is 60 months.
5. Delaney Company’s incremental borrowing rate is 12% a year (1% a month). Simon’s implicit rate is unknown.
(a) What is the nature of this lease to Delaney Company?
(b) What is the present value of the minimum lease payments?
(c) Record the lease on Delaney Company’s books at the date of inception.
(d) Record the first month’s depreciation on Delaney Company’s books (assume straight-line).
(e) Record the first month’s lease payment.