Question

"Karla Salons leased equipment from Smith Co. on July 1, 2021, in a finance lease. The present value of the lease payments discounted at 10% was $81,100. Ten annual lease payments of $12,000 are due each year beginning July 1, 2021. Smith Co. had constructed the equipment recently for $66,000, and its retail fair value was $81,100.

i. The total decreased in earnings (pretax) in Karla´s December 31, 2021, income statement would be (do not compute taxes):
a. $5,000. b. 6,205. c. $7,510. d. $8,400. e. 9,000. f. 15,722.
ii. What amount did Smith Co. record in its income statement for the reporting year ending December 31, 2021, in connection with the lease? (do not compute taxes)
a. $3,455. b. 15,100. c. $18,555. d. $22,010. e. 17,200. f. 22,410."

Answer 1

Solution 1:

Interest expense recordd by Karla for year ended Dec 31, 2021 = ($81,100 - $12,000)*10%*6/12 = $3,455

Depreciatione expense to be recorded by Karla for year ended Dec 31, 2021 = $81,100/10*6/12 = $4,055

total decreased in earnings (pretax) in Karla´s December 31, 2021 = $3,455 + $4,055 = $7,510

Hence option c is correct.

Solution 2:

Sales revenue for smith = $81,100

Cost of goods sold for Smith = $66,000

Interest revenue for smith = ($81,100 - $12,000)*10%*6/12 = $3,455

Amount did Smith Co. record in its income statement for the reporting year ending December 31, 2021, in connection with the lease = $81,100 + $3,455 - $66,000 = $18,555

Hence option c is correct.