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Problem 1: Lessee accounting:
Forbes Company on January 1, 2008, enters into a five-year non-cancelable lease, with four renewal
options of one year each, for equipment having an estimated useful life of 10 years and a fair value to the
lessor, Holt Corp., at the inception of the lease of $3,000,000. Forbes’s incremental borrowing rate is 8%.
Forbes uses the straight-line method to depreciate its assets. The lease contains the following provisions:
1. Rental payments of $219,000 including $19,000 for property taxes, payable at the beginning of each
six-month period.
2. A termination penalty assuring renewal of the lease for a period of four years after expiration of the
initial lease term.
3. An option allowing the lessor to extend the lease one year beyond the last renewal exercised by the
lessee.
4. A guarantee by Forbes Company that Holt Corp. will realize $100,000 from selling the asset at the
expiration of the lease. However, the actual residual value is expected to be $60,000.
Instructions
(a) What kind of lease is this to Forbes Company?
(b) What should be considered the lease term?
(c) What are the minimum lease payments?
(d) What is the present value of the minimum lease payments? (PV factor for annuity due of 20 semiannual payments at 8% annual rate, 14.13394; PV factor for amount due in 20 interest periods at
8% annual rate, .45639.) (Round to nearest dollar.)
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