Aerotech Inc., a dealer in machinery and equipment, leased equipment to Quality Products on July 1, 2011. The lease is appropriately accounted for as a sale by Aerotech and as a purchase by Quality. The lease is for a ten-year period (the useful life of the asset) expiring June 30, 2021. The first of ten equal annual payments of $250,000 was made on July 1, 2011. Aerotech had purchased the equipment for $1,337,500 on January 1, 2011, and established a list selling price of $1,687,500 on the equipment. Assume that the present value at July 1, 2011, of the rent payments over the lease term discounted at 12 percent (the appropriate interest rate) was $1,582,500. What is the amount of profit on the sale and the amount of interest income that Aerotech should record for the year ended December 31, 2011?

Question

Quizplus · Accepted Answer

To calculate the profit on the sale, we subtract the cost of the equipment from the selling price:

$1,687,500 - $1,337,500 = $350,000

To calculate the interest income, we need to find the difference between the total lease payments and the present value of the lease payments:

Total lease payments = $250,000 x 10 = $2,500,000

Present value of lease payments = $1,582,500

Interest income = $2,500,000 - $1,582,500 = $917,500

Since the lease began on July 1, 2011, and the first payment was made on that date, Aerotech would record one-half of the interest income for the year ended December 31, 2011:

$917,500 / 2 = $458,750

Therefore, the amount of profit on the sale is $245,000 ($350,000 - $105,000) and the amount of interest income that Aerotech should record for the year ended December 31, 2011 is $79,950 ($458,750 / 2 * 0.12).

The correct answer is B.