On January 1st, 2014, ABC Inc.(the lessor)agrees to lease a piece of specialized piece of machinery to DEF Inc.(the lessee)for 5 years.ABC Inc.is a financial intermediary specializing in leasing arrangements such as the one described below.Details are as follows: Fair value of machinery at inception of the lease: $100,000.Lease term: 5 years (no bargain renewal terms).
Executory costs of $10,000 are reimbursed by the lessee.
5 Annual lease payments of $23,000 each are made on January 1st of each year starting on January 1st, 2014.
Bargain purchase option at end of lease: $5,000.It is estimated that the equipment will have a fair value of $10,000 at the end of the lease.
Economic life of the asset is 10 years, after which the equipment will be worthless.Straight-line depreciation applies.
ABC's implicit interest rate with respect to this lease is 10%.This is rate is known by DE Inc.
DEF Inc's incremental borrowing rate is 9%.
What would be the amount of finance revenue that ABC Inc.would recognize throughout the lease?
A)$20,000
B)$23,000
C)$5,000
D)$15,000

Question

Quizplus · Accepted Answer

The finance revenue is calculated as the difference between the total lease payments and the present value of the lease payments. The present value of the lease payments, including the bargain purchase option, is $100,000. The total lease payments are $115,000 ($23,000 x 5). The finance revenue is $115,000 - $100,000 = $15,000.