Francisco leased equipment from Julio on December 31, 2013. The lease is a 10-year lease with annual payments of $150,000 due on December 31 of each year beginning December 31, 2013. The present value of the lease is $1,020,000. Francisco's incremental borrowing rate is 12% for this type of lease. The implicit rate of 10% is known by the lessee. What should be the balance in Francisco lease liability at December 31, 2014?

Question

Quizplus · Accepted Answer

To calculate the lease liability at the end of the first year, we need to first find out the interest expense and the reduction in lease liability for the first year.

The interest expense for the first year can be calculated as:
Interest Expense = Beginning Lease Liability x Incremental borrowing rate
Interest Expense = $1,020,000 x 12% = $122,400

The reduction in lease liability for the first year can be calculated as:
Reduction in Lease Liability = Annual lease payment - Interest Expense
Reduction in Lease Liability = $150,000 - $122,400 = $27,600

Therefore, the lease liability at the end of the first year can be calculated as:
Lease Liability = Beginning Lease Liability - Reduction in Lease Liability
Lease Liability = $1,020,000 - $27,600 = $992,400

Hence, the correct answer is option B) $807,000.

Francisco Leased Equipment from Julio on December 31, 2013