Question

Western Company leased equipment from Sunshine Industries. The lease agreement qualifies as a finance lease and requires annual lease payments of $120,000 over a five-year lease term (also the asset’s useful life), with the first payment at January 1, 2018, the beginning of the lease. The interest rate is 9%. The asset being leased cost Sunshine $500,000 to produce. The total increase in earnings (pretax) on Sunshine’s December 31, 2018, income statement would be:

a. $0
b. $35,534
c. $43,755
d. $51,375

Answer 1

Calculation of present value of lease payments
Year	Lease payments	Discount factor @ 9%	Present Value
0	$120,000.00	1.00000	$120,000.00
1	$120,000.00	0.91743	$110,091.74
2	$120,000.00	0.84168	$101,001.60
3	$120,000.00	0.77218	$92,662.02
4	$120,000.00	0.70843	$85,011.03
Present Value of lease payments			$508,766.39
As this is finance lease transaction , Sunshine (lessor) will book the revenue on sale of an asset with following journal entry
Date	Account Title	Debit	Credit
Jan.1,2018	Lease receivables	$508,766
	Sales		$508,766
Jan.1,2018	Cost of goods sold	$500,000
	Inventory		$500,000
Sunshine will record the interest lease transactions for 2018 as under,
Date	Account Title	Debit	Credit
Jan.1,2018	Cash	$120,000
	Lease receivables		$120,000
Jan.31,2018	Interest Receivable	$34,989
	Interest Income		$34,989
The total increase in earnings (pretax) on Sunshine’s December 31, 2018, income statement would be:
Profit Margin on sale = Sales - Cost of goods sold = $508766 - $500000 =				$8,766
Interest Income of lease liability [($508766-$120000)*9%] =				$34,989
The total increase in earnings (pretax) on 2018 income Statement				$43,755
The answer is Option c.