Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 8% Pisa, Inc. uses the straight-line method to amortize similar assets. What is the amount of amortization expense recorded by Pisa, Inc. in the first year of the asset’s life?

Complete Question:

Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $344,152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Pisa, Inc. uses the straight-line method to amortize similar assets. What is the amount of amortization expense recorded by Pisa, Inc. in the first year of the asset’s life?

                               PV Annuity Due        PV Ordinary Annuity

8%, 4 periods                  3.57710                          3.31213

10%, 4 periods                3.48685                         3.16986

a.   $0 because the asset is amortized by Tower Company.

b.   $284,968

c.   $307,767

d.   $300,000

$307,767

Explanation:

We have to calculate the annuity value to estimate the value of the right to use and this is given as under:

Right to Use Value = Equal Annual Payments * (PV of Annuity due at 8%)

Here

Equivalent Annual Payment is $344,152

PV of Annuity due at 8% is 3.57710

By putting values, we have:

Right to Use Value = $344,152 * 3.57710 = $1,231,066

Now we will find amount of amortization expense recorded for first year:

Per year Amortization = $1,231,066 / 4 Years = $307,767