On December 31, 2009, Perry Corporation leased equipment to Admiral Company for a 5-year period. The annual lease payment, excluding executory costs is $40,000. The interest rate for this lease is 10%. The payments are due on December 31 of each year. The first payment was made on December 31, 2009. The normal cash price for this type of equipment is $125,000 while the cost to Perry was $105,000. For the year ended December 31, 2009, by what amount will Perry's pretax earnings increase from this lease?

Question

Quizplus · Accepted Answer

Perry's pretax earnings will increase by the amount of the first lease payment received, which is $40,000, minus the interest income recognized for the year. The interest income for the first year is calculated as 10% of the normal cash price of $125,000, which is $12,500. Therefore, the increase in pretax earnings is $40,000 - $12,500 = $27,500. However, since the cost of the equipment is $105,000, the gross profit on the sale is $125,000 - $105,000 = $20,000. Thus, the pretax earnings increase by $20,000.

On December 31, 2009, Perry Corporation Leased Equipment to Admiral