On January 1,2014,ABC INC.leased a machine to MNO.The lease was for a 10-year period,which approximated the useful life of the machine.ABC INC.purchased the machine for $120,000 and expects to earn a 10 percent return on its investment,based upon an annual rental of $17,754 payable in advance each January 1st.Assuming that the lease was a direct financing lease,what should be the interest entry on ABC INC.'s books on December 31,2014?

Question

Quizplus · Accepted Answer

To determine the interest portion of the lease payment, use the following formula:
Interest Expense = Lease Receivable x Interest rate
The lease receivable is the present value of the annuity payment, which can be calculated using the present value of an annuity formula:
Present value of annuity = Annual rental x present value of 1 for n periods at the interest rate
n= number of lease payments
The present value of 1 is derived from the present value tables at 10% for 10 periods.
Present value of 1 = 0.38554
Present value of annuity = $17,754 x 0.38554 = $6,834.42
Lease receivable = $6,834.42
Interest expense = $6,834.42 x 10% = $683.44

Therefore, the interest entry on ABC INC.'s books on December 31, 2014, should be $683.44, which is option B.