In: Accounting
Corry Corp. leased equipment from First Corp. under a 4-year lease requiring equal annual payments of $344,152, 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. Corry’s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Corry, Inc.) is 8%. Assuming that this lease is properly classified as a finance lease, what is the amount of interest expense recorded by Corry in the first year of the asset’s life?
ANS: $70,953
Please explain why the answer is as is.
Step 1: Calculation of Present value of annuity due: | ||
Beginning of the year 1 | (1/1.08)^0 | 1 |
At the end of year 1 or at the beginning of the year 2 | (1/1.08)^1 | 0.925926 |
At the end of year 2 or at the beginning of the year 3 | (1/1.08)^2 | 0.857339 |
At the end of year 3 or at the beginning of the year 4 | (1/1.08)^3 | 0.793832 |
Present value of annuity due | 3.577097 |
Calculation of value of the asset: | |
Present value of annuity due | 3.5771 |
1st installment of lease | 344152 |
Value of the asset (3.577097*344152) | 1231065 |
Calculation of Interest to be recorded in first year of asset life: | |
Value of the asset (3.577097*344152) | 1231065 |
Less: First installment to be paid at the beginning of the lease | 344152 |
Principal amount outstanding for the year one (1231065 - 344152) | 886913 |
Implicit rate in the lease | 8% |
Interest to be recorded in first year of asset life: (886913*8%) | 70953 |