- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 8. Topics in Long-Term Liabilities and Equity
- Subject 3. Accounting and Reporting by the Lessee

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**CFA Practice Question**

West Company leased a new machine from South Company on May 1, 2015 for 10 years with annual lease payments of $40,000 at the start of each lease year. The machine has an estimated useful life of 12 years. The appropriate discount rate to be used is 14% and the present value of $1 for 10 periods at 14% is 0.27. The present value of an annuity of $1 for 10 periods at 14% is 5.95. The lease contract included a residual value guarantee of $50,000. West should record a capitalized leased asset on their books of ______.

B. $238,000

C. $224,500

A. $251,500

B. $238,000

C. $224,500

Correct Answer: A

Since it is guaranteed, the $50,000 residual value is discounted as a lump sum for 10 years at 14%. The $40,000 lease payment is an annuity that is discounted. The correct computation is [($50,000 * .27) + ($40,000 * 5.95)] = $13,500 + $238,000 or $251,500.

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**User Contributed Comments**
11

User |
Comment |
---|---|

kalps |
NB it is guaranteed so it will be paid at the end of teh period. If it was an option then you would look at the probability of exercising that option and make a conservative estimate |

isida |
the residual value guarantee is discounted as a lump sum |

o123 |
** PV OF THE $1 ANNUITY IS NOT 5.95, ITS 5.216!! Value of 40,000 annuity: N=10, i/y=14, pmt=40,000 CPT PV= 208,645 value of 50,000 Lump sum: N=10, i/y=14, FV=50,000 CPT PV= 13,487 BV; 13,487 + 208,645 = 222,132 |

o123 |
Wow...sorry people I'm going to have to take back that last comment once again...and take my hat off to the people at AN aswell. Just noticed the fine print: the lease payment is at the beginning of the period (Annuity Due)! so set your calc to the BGN mode and run the same calculations. |

quynhnk79 |
Great, you so responsible man! Thank you. |

quanttrader |
add PV of guarantee to PV of lease payment annuity. |

thekobe |
just make the calculation of the annuity and you get $238, but since you have to include the residual value, the answer should be greater, so your choice is A |

johntan1979 |
If you used the TVM menu, the answer is $251,342 due to rounding differences. |

gill15 |
Problem with this question is it say the PV of an annuity of 1 for 10 periods = 5.95. They should tell us if the PV value of the annuity of 5.95 pertains to an annuity due or immediate. I assumed the 5.95 was for immediate but its due. |

Shaan23 |
With Lease payments at BOYear this is an annuity due. It does NOT state if 5.95 is for an anuity due or immediate. With first reading I would say it is Annuity immediate and needs to be converted. |

farrahkame |
lol what. |