Question

On January 1, Year 1, the Timble Corporation (Timble) leases a piece of typical equipment to use for eight years. The equipment has an expected life of ten years and no anticipated salvage value. Timble has an incremental borrowing rate of 5%. Annual payments for this asset are $9,000 with the first payment to be made immediately. At the end of the eight years, Timble has the right to buy the asset for $10,000 in cash. This amount is expected to be significantly below the expected fair value of the equipment on that date so it is reasonable to expect Timble to pay this amount. Timble records depreciation based on the straight-line method and interest based on the effective rate method. The present value of an annuity due of $1 at 5% for eight years is assumed to be 6.80. The present value of an ordinary annuity of $1 at 5% for eight years is assumed to be 6.50. The present value of a single amount of $1 at 5% in eight years is assumed to be 0.66. What amount of depreciation expense should Timble record for Year 1

Answer 1

Answer: $6780

Explanation:

Asset recorded in books of timble will be:

= (PVAF at 5%, 8 × Annual CF) + (PVAF at 5%,8 × salvage)

where CF = cash flow

PVAF = present value of annuity factor

= (6.80 × 9000 ) +(0.66 × 10000)

= 61200+ 6600

= $ 67800

Since the equipment has an expected life of ten years with no anticipated salvage value, then the depreciation will be:

Depreciation = 67800 ÷ 10

= $ 6780