Question

QRS Company leases out an asset for 4 years to TUV Inc. During the term of the lease, TUV must make a payment of $5,000 each year for using the asset. The rate implicit in the lease is 8%. The lease is classified as a finance lease and both companies use straight line depreciation and zero salvage values to depreciate all fixed assets.

If the asset had cost QRS $14,000, net income in Year 3 would be closest to:

a.713

b.640

c.1353

The answer is a. Can somebody explain this to me?

Answer 1

Present Value of series of payments of $ 5,000 at 8% is $ 16,561 which can be explained as per below table

For QRS
Year	Payment received (a)	PV @ 8% (b)
1	5,000	4,630
2	5,000	4,287
3	5,000	3,969
4	5,000	3,675
	20,000	16,561

Now, considering $16,561 as opening balance, following is the schedule of income

Year	Principal	Interest @ 8%	Payment	Closing Balance
1	16,561	1,325	5,000	12,886
2	12,886	1,031	5,000	8,917
3	8,917	713	5,000	4,630
4	4,630	370	5,000	0
		3,439	20,000

Hence Income earned in Year 3 is $ 713.