Question

On 1/1/16, black co. (lessee) recorded a right of use asset of $100,000 for a 10-year lease agreement. payments of $12,575 are made annually at the beginning of each rental year, with the first payment paid on 1/1/16. the lessor’s implicit rate is 5.5%, which approximates Black’s incremental borrowing rate.

Black classifies the lease as a finance lease, but not as a result of a bargain purchase option or title transfer. the leased equipment has an estimated useful life of 15 years, with no expected salvage value. Black uses the straight-line method for all depreciation and amortization. What is the total expense that will be recognized by black in 2017 for this finance lease?

Answer 1

Sol:

Period	cash (in $)	interest expensen (in $)	Liability reduction(in $)	Liability balance(in $)
	A	B	A-B	100000.00
2016	12575	5500.00	7075.00	92925.00
2017	12575	5110.88	7464.13	85460.88
2018	12575	4700.35	7874.65	77586.22
2019	12575	4267.24	8307.76	69278.47
2020	12575	3810.32	8764.68	60513.78
2021	12575	3328.26	9246.74	51267.04
2022	12575	2819.69	9755.31	41511.73
2023	12575	2283.14	10291.86	31219.87
2024	12575	1717.09	10857.91	20361.96
2025	12575	1119.91	11455.09	8906.87

There total expense recognised by black co. in 2017 is $7464.13

the implicit rate of 5.5% is savings in interest expense for lessee, which is to be deducted from intial payment of ($12,575) every year

The interest is calculated on reducing balance of every year ( Previos year liability balance - liability reduction of current year)