Mark Richards Ltd enters a finance lease to lease an asset from Michael Petersen Ltd. Thelease term is for seven years and the leased asset is initially recorded in Mark RichardsLtds accounts for $250 000 at the date of lease inception. The asset is expected to have auseful life of eight years. The lease terms include a guaranteed residual of $20 000 andthat the asset is expected to have a residual value of $10 000 at the end of its useful life.

REQUIRED

Determine the lease depreciation expense assuming that:

(a) Mark Richards Ltd is expected to get ownership of the asset at the end of the leaseterm

(b) Mark Richards Ltd is not expected to get ownership of the asset at the end of thelease term.

Solution:

(a) The guaranteed residual is included in the minimum lease payments, and hence is included in the $250 000. If the lessee is expected to retain the asset at the end of the lease term then the lease asset should be depreciated over the useful life of the asset. Depreciation expense per year = ($250 000 - $10 000) 8 = $30 000

(b) If the lessee expects to return the asset to the lessee at the end of the lease term, and to the extent that the asset has a value equal to the guaranteed residual at the end of the lease term (meaning that the lessee can return the asset at the end of the lease term and have no further obligation to transfer additional money) then the depreciation would be:

Present value of minimum lease payments $250 000

Less, present value of guaranteed residual (included in minimum lease payments) and we will assume an implicit rate of 10 per cent: 20 000 x 0.5132 10,264

$239 736

Depreciation: $239 736 7 $34 248

my questions:

For b) why use 10% asimplicit rate? Can i use other rate rather than 10%?