On January 1, Espinoza Moving and Storage leased a truck for a four-year period,
ID: 2558301 • Letter: O
Question
On January 1, Espinoza Moving and Storage leased a truck for a four-year period, at which time possession of the truck will revert back to the lessor. Annual lease payments are $10,000 due on December 31 of each year, calculated by the lessor using a 5% discount rate. If Espinoza’s revenues exceed a specified amount during the lease term, Espinoza will pay an additional $4,000 lease payment at the end of the lease. Espinoza estimates a 60% probability of meeting the target revenue amount.
What amount should be added to the right-of-use asset and lease liability under the contingent rent agreement?
Explanation / Answer
Lease agreement is a contract where the right to use the asset is transferred from the lessor (owner of the instrument ) to lessee (the person to whom the right is transfered) for a specific period or purpose, for which lessor charges rent.
Lease payment = $10,000 per year.
Discount rate = 5%
Amount to be added for right-of-use = (Guaranteed Value - Residual Value) * Present Value factor.
Guaranteed Value = Annual Lease payments (Since guaranteed value is not given in the question, we can take annual lease payments as guaranteed value)
The future payments may vary because of the changes in index value each year.
Thats why, additional $4,000 additional amount has to be excluded even if E's 60% probability of meeting the desired or target revenue amount.