Question

Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a operating lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line amortization for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%. What amount of amortization expense should be recorded for 2021?

Answer 1

Answer: $120,000

Explanation:

Depreciation is to be based on the cost of the asset being depreciated. In this scenario, the cost of the heavy duty drill press will be the Present Value of all the lease payments for the entire 10 years because it is said that the title will pass to Hernandez Inc. afterwards so the lease payments can be considered as payment.

Straight Line Amortisation = $\frac{Cost of Asset - Salvage Value}{Estimated Useful Life}$

Straight Line Amortisation = $\frac{1,800,000 - 0}{15}$

Straight Line Amortisation = $120,000 per year