work paper for the lease liability. Assume that the quarterly payments are due on April 1, July 1, October 1, and January 1. Include all necessary audit legends as evidence of procedures performed. (1. Draft any audit adjustments indicated by the work paper prepared in (c). Answer: Requirement (a) The following additional information is needed to determine the proper lease classification as financing or operating: 1. The fair value of the building space as of the date on which the lease agreement was signed. 2. The initial lease term and whether a bargain purchase or renewal option is available at the end of the term. 3. The estimated useful life of the property. 4. Whether the quarterly lease payments include provision for executory costs (insurance, taxes, etc.) 5. Whether the residual value is guaranteed by Pine Requirement (b) The following auditing procedures should be applied in gathering the information meeting the requirements set forth in (a) above: 1. Examine the lease agreement for details surrounding the initial lease term, payment of executory costs, and the existence of purchase or renewal options. 2. Examine appraisal reports and property tax bills for an indication of fair value at date of lease. 3. Inquire of management or confirm with lessor as to the estimated useful life of the property. Requirement(c) Pine, Inc. Obligation under Capital Leases, 2006 December 31, 2006 1/1/06: Liability as calculated: NPV of P150,000 per period for 40 periods at 3% per period (ordinary annuity) P 3,467,215 4/1/06: Payment: Interest (3% X P 3,467,215) = P 104,016 Principal (P 150,000 - P 104,016) (45,984) 7/1/06: Payment: Interest [3% x (P 3,467,215 - P 45,985)] = P 102,637 Principal (P 150,000 - P 102,637) (47,363) 9/1/06: Payment: Interest [3% X (P 3,467,215 - P 45,984 - P 47,363)] = P 101,216 Principal (P 150,000 - P 101,216) (48,784! 12/31/06: Principal balance P 3,325,084 Requirement (d) Audit adjustments: (1) Lease Property 3,467,215 Interest Expense 30 7,869 nlwlinafinn Ilnrlar- Fani'l'nl 1 gang '3. '1'): nR/l