On January 2, 2020, Micheal (lessee) entered into a 10-year non-cancelable lease with Thomas (lessor) for equipment. The following facts relate to the transaction:

-The equipment has an estimated useful life of 13 years.

-There is no purchase option. Transfer of ownership to Michael is not stipulated in the lease contract.

-The fair value to Thomas (lessor) at the inception of the lease was $4,000,000. Lessor's cost was $3,775,000. Sales commissions were $2,500.

-Michael's incremental borrowing rate is 10%. The implicit annual rate in the lease (known to Michael) is 8%.

- Michael and Thomas use straight-line depreciation.

-The lease requires rental payments of $266,000, payable on 1/2/20 and subsequently on 6/30 and 12/31.

-Michael guarantees that Thomas will realize $200,000 from selling the asset at the end of the lease. The expected residual value is $120,000.

1. Refer to the original facts. However, also assume that Micheal had to pay semi-annual insurance premiums ranging from an estimated $800 to $2,100 and that Micheal incurred $2,400 to execute the lease. Discuss at what amount Micheal should record the ROU asset.

Given Tip: Credit Cash 2,400 for initial direct cost; executory costs are variable

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