Elton Electronics leases testing equipment to Startup Corporation. The equipment is not specialized and is delivered on January 1, 2019. The fair value of the equipment is $98,000. The cost of the equipment to Elton is $93,000 and the expected life of the testing equipment is 8 years. Elton incurs initial direct costs of $10,000, which they elect to expense. The lease term for the equipment is 8 years, with the first payment due upon delivery, and seven subsequent annual payments beginning on December 31, 2019 and ending on December 31, 2025. Elton's implicit rate is 8% and they expect that collection of the $12,500 lease payments is probable. How much interest will Elton record for 2019?
A) $12,500
B) $7,294
C) $5,206
D) $6,206

Question

Quizplus · Accepted Answer

The interest for 2019 is calculated on the net investment in the lease after the first payment. The initial lease receivable is the present value of the lease payments, which is $12,500 * 7.0187 (PV factor for 8% over 8 years) = $87,734. The first payment of $12,500 reduces this to $75,234. Interest for 2019 is 8% of $75,234, which is $6,019. However, since the first payment is made at the start, the interest for 2019 is calculated on the remaining balance after the first payment, which is $75,234, leading to $6,019 in interest.

Elton Electronics Leases Testing Equipment to Startup Corporation