Question

Use the following information for questions 16–17.

On January 2, 2017, Cambridge Ltd. signed a ten-year non-cancellable lease for a heavy-duty drill press. The lease required annual payments of $35,000, starting December 31, 2017, with title passing to Cambridge at the end of the lease. Cambridge is accounting for this lease as a capital (finance) lease. The drill press has an estimated useful life of 20 years, with no residual value. Cambridge uses straight-line depreciation for all its plant assets. The lease payments were determined to have a present value of $215,000, based on an implicit interest rate of 10%.

16. On their 2017 income statement, how much interest expense should Cambridge report in connection with this lease?

a) $0

b) $13,125

c) $17,500

d) $21,500

17. On their 2017 income statement, how much depreciation expense should Cambridge report in connection with this lease?

a) $10,750

b) $17,500

c) $21,500

d) $35,000

Answer 1

(16) On their 2017 income statement, how much interest expense should Cambridge report in connection with this lease?

Interest Expense = Present value of lease payments * implicit interest rate

= $215000 * 10% = $21500

Option (d) is correct

(17) On their 2017 income statement, how much depreciation expense should Cambridge report in connection with this lease?

Depreciation Expense = (Present value of lease payments - Residual value)/Useful Life of asset

= ($215000 - $0)/20 years = $10750

Option (a) is correct