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Owl leases an asset with an estimated useful life of 6 years for an initial period of 5 years, and an optional secondary period of 2 years during which a nominal rental will be payable. The present value of the initial period lease payments is $87,000.
What will be the carrying amount of the right of use asset in Owl’s SOFP at the second year of the lease?
I calculated $52,500 taking 5 years as they say shorter of the two.
But in the Kaplan answer section they take 6 year period. And the answer is $58,000.
I couldn’t understand this part.
Could you help me please?
Thank you.
Hi,
A question like this is designed to deliberately catch students out. Your understanding of using the shorter of the lease period and useful life is correct to depreciate the ROU asset but there is a catch with the lease period.
As there is the option to extend the lease by 2 years for the nominal rental then we assume that we would do this as it makes economic sense. The lease period is therefore now 7 years (5 + 2) and so the shorter is the 6 year useful life.
Thanks.
Thank you for taking your time to help me.
Sir I still have 2 questions.
1. Do we have to discount back the nominal rentals to PV as well?
2. How is it economical to take 6 years as the useful life?
Thank you Sir. And also sorry for the trouble.
I have been doing the question again and maybe I do understand what the question meant.
Am I right to think that the nominal value for next 2 years after the initial 5 years will be ‘x’ amount but lower than the PV 87,500.
And when added together will cost a bit more than 87,500, ie 87,500+x, which is not economical because it is costing us more.
So therefore 87,500 over 6 years is more economical?
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