Question

Carla Vista, Inc. leased equipment from Tower Company under a 4-year lease requiring equal annual payments of $294152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Carla Vista, Inc.’s incremental borrowing rate is 11% and the rate implicit in the lease (which is known by Carla Vista, Inc.) is 8%. Assuming that this lease is properly classified as a finance lease, what is the amount of interest expense recorded by Carla Vista, Inc. in the first year of the asset’s life?

PV Annuity Due PV Ordinary Annuity

8%, 4 periods 3.57710 3.31213

11%, 4 periods 3.44371 3.10245

$60645

$32357

$77942

$0

Answer 1

Calculation of Lease liability
Year	Lease payment	Present value factor @ 8%
0	$                 294,152	1	$      294,152
1 to 3	$                 294,152	2.577	$      758,030
			$   1,052,182
Calculation of interest expense
Year	Opening balance	Interest	Lease payment	Closing balance
0	$              1,052,182	0	$      294,152	$    758,030
1	$                 758,030	$           60,642	$      294,152	$    524,520
2	$                 524,520	$           41,962	$      294,152	$    272,330
3	$                 272,330	$           21,822	$      294,152	$                0
	Total interest	$         124,426

Interest taht will be accrued in the 1st year will be $60,642.

Hence option 1 is correct.

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