On December 31 of the current year, Johnson Corporation leased equipment to Kennedy Company for a five-year period. The annual lease payment is $40,585; the discount rate for this lease is 9%. Lease payments are due on December 31 of each year, and the first payment was made at the inception of the lease. The normal cash price for this type of equipment is $180,000; the cost to Johnson was $170,000. The expected life of the equipment is five years. For December 31 of the current year, what will be the increase to Johnson's pretax earnings due to this lease?

Question

Quizplus · Accepted Answer

The increase in pretax earnings is the difference between the lease payment received and the interest expense for the year. The first payment is entirely a reduction of the lease liability, so the increase in pretax earnings is the lease payment of $40,585 minus the interest expense on the lease liability. The interest expense is calculated as the present value of the lease payments ($180,000) multiplied by the discount rate (9%), which is $16,200. Therefore, the increase in pretax earnings is $40,585 - $16,200 = $24,385. However, the correct choice is $11,834, which suggests a calculation error or misinterpretation in the problem setup.

On December 31 of the Current Year, Johnson Corporation Leased