Question

On December 31, 2016, IU Corporation signed a 6-year, non-cancelable lease for a machine. The terms of the lease called for IU Corporation to make payments of $12,108 at the beginning of each year, starting December 31, 2016. The machine has an estimated useful life of 8 years and a $6000 unguaranteed residual value. The machine reverts to the lessor at the end of the lease term. IU Corporation uses the straight-line method of depreciation for all of its plant assets. IU’s incremental borrowing rate is 8 percent, and the lessor’s implicit rate is unknown.

On December 31, 2017, how much would IU Corporation DEBIT interest expense (rounded to the nearest dollar)?

Answer 1

Facts of the question:

Number of Years = 8

Incremental borrowing rate = 8%

Payments at the beginning of each year (PMT)= $12,108

Present Value(PV) = $71,906

Unguaranteed residual value = $6000

The answer has been solved in the two steps detailed in the sheets (Attached)

Answer to the given question has been solved in two Steps detailed below: Step 1: Identify the type of lease There is no bargain purchase option because the equipment will revert back to the lessor. The life of the lease is 8 years and the economic life of the asset is 8 years. Number of Years = 8 Incremental borrowing rate = 88% Payments at the beginning of each year (PMT)- 512,108 Present Value(PV) = 571,906 Unguaranteed residual value = 56000 Step 2: Lease amortization schedule Years Year PMT in $ Rate 12108 12108 12108 12108 12108 12108 12108 12108 6000 Discount factd PV 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 12,108 11,211 10,381 9,612 8,900 8,241 7,630 7,065 3,242 78,390 Year End On December 31, 2017 On December 31, 2018 On December 31, 2019 On December 31, 2020 On December 31, 2021 On December 31, 2022 On December 31, 2023 On December 31, 2024 Opening Interest Balance Expense 66,282 5,303 59,4771 4,758 52, 127 4,170 44,189 3,535 35,616 2,849 26,357 2,109 16,358 1,309 8 5,559 445 24,478 Payment 12,108 12,108 12, 108 12,108 12,108 12,108 12,108 6,000 Principal Payment 6,805 7,350 7,938 8,573 9,259 9,999 10,799 5,559 Closing Balance 59,477 52,127 44, 189 35,616 26,357 16,358 5,559 Note: The equipment account is debited by the present value of the minimum lease payments and the lease liability account is the difference between the value of the equipment and cash paid at the beginning of the year. Answer to the question: Question: On December 31, 2017, how much would IV Corporation DEBIT interest expense (rounded to the nearest dollar)? Answer: On December 31, 2017, IV Corporation Debit interest expense $5,303. Equipment Cash 78,390 12,108 66,282 12,108