Question

Beta Company leased equipment from Summer Industries. The lease agreement qualifies as a finance lease and requires annual lease payments of $50,000 over an eight-year lease term (also the asset’s useful life), with the first payment at January 1, 2019, the beginning of the lease. The interest rate is 6%. The asset being leased cost Summer $300,000 to produce. Costs of $5,866 for legal fees for the lease execution were the responsibility of the lessor. The total increase (decrease) in earnings (pretax) on Summer’s December 31, 2019, income statement would be

Answer 1

In the books of Summer Industries

Increase/Decrease in pretax earnings for Dec 31 2019 = $20253

Notes

Lets first calculate the present value of lease payments made over the 8 year term

Hence, PV of annuity of $50,000 @6% discount rate for 8 years = 50000*6.2098 = $310490

Cost of Lease = $300000

Hence, PV of lease payments = $10,490

Add: Interest Income = ($310490 - $50,000) * 6% = $15,629

Less: Legal Fees= $5866

Net increase in earnings = 10490+15629-5866 = $20253

Please comment in case of any issue and I will be happy to rectify it.