Question

Nichols Fruits leased farm equipment from King Machinery on January 1, 2020. The present value of the lease payments discounted at 10% was $40 million. Ten annual lease payments of $6 million are due at the beginning of each year beginning January 1, 2020. King had constructed the equipment recently for $33 million. With this lease agreement, control is considered to be transferred to the lessee at the beginning of the lease. The total increase in earnings (pretax) in King's 2020 income statement would be:

A. $3.4 million

B. $6.0 million

C. $17.0 million

D. $10.4 million

Please show work

Answer 1

Total increase in earnings (pretax) in Kings's 2020 income statement would be :

=interest revenue from lease+Selling profit at the beginning of lease

(1) Interest revenue

=($40 Million-$6 Million)]*10%

=$3.4 Million

(2) Selling profit at the beginning of lease

=[Present value of lease payment-cost of Construction]

=[$40Million-$33 Million]

=$7 Million

The total increase in earnings (pretax) in King's 2020 income statement would be:

$3.4 Million+$7 Million

=$10.4 Million

Answer D