Hert Corporation acquired a capital lease that is carried on its books at a present value of $100,000 (discounted at 12%). Its annual rental payment is $15,000. What is the amount of interest expense from this lease? $\begin{array} { l c c }
&\underline{ \text { First Year }} & \underline{\text { Second Year }} \\end{array}$
A. $\begin{array} { l c c } & \$ 12,000 & \$ 10,200 \\end{array}$
B.$\begin{array} { l c c } & \$ 12,000 & \$ 11,640 \\end{array}$
C. $\begin{array} { l c c } & \$ 12,000 & \$ 12,350 \\end{array}$
D.$\begin{array} { l c c } & \$ 15,000 & \$ 15,000
\end{array}$

Question

Hert Corporation acquired a capital lease that is carried on its books at a present value of $100,000 (discounted at 12%). Its annual rental payment is $15,000. What is the amount of interest expense from this lease? $\begin{array} { l c c } 
&\underline{ \text { First Year }} & \underline{\text { Second Year }} \\end{array}$
A. $\begin{array} { l c c } & \$ 12,000 & \$ 10,200 \\end{array}$
B.$\begin{array} { l c c } & \$ 12,000 & \$ 11,640 \\end{array}$
C. $\begin{array} { l c c } & \$ 12,000 & \$ 12,350 \\end{array}$
D.$\begin{array} { l c c } & \$ 15,000 & \$ 15,000
\end{array}$

Quizplus · Accepted Answer

The interest expense from the lease is the difference between the annual rental payment and the decrease in the lease liability. The decrease in lease liability is the difference between the present value of the lease and the remaining liability at the end of the year.

At the beginning of the lease, the liability is $100,000. The annual rental payment is $15,000, which includes both principal and interest. To determine the interest portion of the payment, we need to subtract the decrease in liability from the rental payment.

To calculate the decrease in liability, we need to find the present value of the remaining payments at the end of the year. Since the lease is carried on the books at a present value of $100,000, we can assume that this is also the present value of the remaining payments. Therefore, the decrease in liability at the end of the year is $100,000 - $15,000 = $85,000.

The interest expense for the first year is therefore $15,000 - $85,000 = -$70,000. This negative amount indicates that Hert Corporation has prepaid the interest expense for the first year. This prepaid amount will be amortized over the life of the lease, resulting in a lower interest expense in future years.

Hert Corporation Acquired a Capital Lease That Is Carried on Its