Question

On January 1, Chen Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Chen to make annual payments of $120,000, beginning at inception of the lease. Title will transfer to Chen at the end of the 5 year lease period. The equipment has an estimated useful life of 7 years and no salvage value. The effective interest rate for the lease is 10% and Chen uses the straight-line method of depreciation for its e assets. РУ$1, п-5, 1-10% 0.62092 NAD, n-5, 1-10% PVOA, n-5, 1-10% 3.79079 At December 31, Chen should record the following amount related to this capital lease: A. interest expense of $33,490 B. interest expense of $45,490 C. interest expense of $38,038 D. interest expense of $50,038.

Answer 1

Correct Answer (c ) Interest Expense of $38,038

Calculations

Calculation of Fair value of Asset
	Payments	Discounting factor
Beginning year 1	$ 120,000.00	1	$ 120,000.00
Ending year 1	$ 120,000.00	0.909090909	$ 109,090.91
Ending year 2	$ 120,000.00	0.826446281	$    99,173.55
Ending year 3	$ 120,000.00	0.751314801	$    90,157.78
Ending year 4	$ 120,000.00	0.683013455	$    81,961.61
Present value of all lease payments/ Fair value of asset			$ 500,383.85

Schedule of interest and principle repayment
	Beginning balance of principle	Payment	Interest	Principle payment	Principle balance
Beginning year 1	$ 500,383.85	$ 120,000.00	$                    -	$ 120,000.00	$ 380,383.85
Ending year 1	$ 380,383.85	$ 120,000.00	$    38,038.39	$    81,961.61	$ 298,422.24
Ending year 2	$ 298,422.24	$ 120,000.00	$    29,842.22	$    90,157.78	$ 208,264.46
Ending year 3	$ 208,264.46	$ 120,000.00	$    20,826.45	$    99,173.55	$ 109,090.91
Ending year 4	$ 109,090.91	$ 120,000.00	$    10,909.09	$ 109,090.91	$                    -