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On January 1, 2019, Pearson Company signed a lease agreement requiring six annual payments of $60,000,...

On January 1, 2019, Pearson Company signed a lease agreement requiring six annual payments of $60,000, beginning December 31, 2019. Pearson's incremental borrowing rate was 9% and the lessor's implicit rate, known by Pearson, was 10%. The present value factors of an ordinary annuity of $1 for six periods for interest rates of 9% and 10% are 4.485919 and 4.355261, respectively.

What would be the interest expense for 2019?

a.21,003. b.22,746. c. 24,224. d.26,132

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Answer #1

The right option is "d.$26,132".

The rate to be used for discounting the lease payments is the implicit rate of the lease. This rate is calcuated from the prospective of the lessor. If the implicit rate is not available then the incremental borrowing rate of the lessee is to be used.
Rate to be used = Lessor's implicit rate = 10%

The lease liability = Annual lease payment * Present value factor of an ordinary annuity of $1 for six periods for interest rate of 10% = $60,000 * 4.355261 = $261,315.66

Interest expense = Lease liability * Interest rate = $261,315.66 * 10% = $26,132 ( rounded off to nearest whole dollar ).

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