A six-year-capital lease entered into on December 31,2008,specified equal minimum annual lease payments due on December 31,2010.Minimum payment applicable to which of the following increased over the corresponding December 31,2010,minimum payment? Reduction of
Interest Expense Liability

Question

Quizplus · Accepted Answer

Since this is a capital lease, the lessee (the one who is leasing the asset) is required to record the leased asset as well as the corresponding liability on their balance sheet. The minimum lease payments consist of two parts: principal and interest.

When the lease payment is made, a portion of it goes towards interest expense and the rest towards reducing the liability. Since this is a six-year lease, there will be six payments consisting of both principal and interest.

Since the lease was entered into on December 31, 2008, the first two lease payments would have been made on December 31, 2009, and December 31, 2010.

The question asks which of the following increased over the corresponding December 31, 2010, minimum payment.

The reduction of the liability would increase over the corresponding December 31, 2010, minimum payment as the lessee would have made two payments by this time, and each payment reduces the liability.

However, the interest expense would not increase over the corresponding December 31, 2010, minimum payment as the interest expense is calculated based on the outstanding liability each year. Since the liability would have reduced between the two lease payments, the interest expense for the second payment would be lower than for the first payment.

Therefore, the answer is C) No for Interest Expense and Yes for Liability.

A Six-Year-Capital Lease Entered into on December 31,2008,specified Equal Minimum