Delaney Company leases an automobile with a fair value of $10,000 from Simon Motors, Inc., on the following terms.

1. Non-cancelable term of 50 months.

2. Rental of $200 per month (at the beginning of each month). (The present value at 0.5% per month is $8,873.)

3. Delaney guarantees a residual value of $1,180 (the present value at 0.5% per month is $920). Delaney expects the probable residual value to be $1,180 at the end of the lease term.

4. Estimated economic life of the automobile is 60 months.

5. Delaney’s incremental borrowing rate is 6% a year (0.5% a month). Simon’s implicit rate is unknown.

Instructions

a. What is the nature of this lease to Delaney?

b. What is the present value of the lease payments to determine the lease liability?

c. Based on the original fact pattern, record the lease on Delaney’s books at the date of commencement.

d. Record the first month’s lease payment (at commencement of the lease).

e. Record the second month’s lease payment.

f. Record the first month’s amortization on Delaney’s books (assume straight-line).

g. Suppose that instead of $1,180, Delaney expects the residual value to be only $500 (the guaranteed amount is still $1,180). How does the calculation of the present value of the lease payments change from part b?